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Silas Keehn: Monetary Policy Remarks December 1987 Economic Forums 12/. 8/.87 -- Kohler/Sheboygan WI (breakfast) 12Z 8i'87 -- Lake County, IL (p.m.) 12/10/87 -- Milwaukee, WI (a.m.) 12/2/87 Slide #1 -- Title Slide: Challenges for Monetary Policy I. If we had met with you two months ago A. Focus of some of my remarks would have been different B. I would have viewed challenges in prospective sense C. But, with events of past two months, focus more on current issues 1. I will, in any event, avoid "I told you so" 2. But, as we shall see, the buildup of certain risks and imbalances 3. To a certain extent set us up for wbat happened ~~-~~ D. Outlook Karl has just given -- very good economic growth and inflation outcomes -- current expansion was 5 years old last month -- moving into 6th year 1. But achievement of our economic growth outlook https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis a. Is highly dependent on a turnaround in our international trade 12/2/87 Policy Remarks Page 2 b. Moreover, greater uncertainty about forecast due to recent stock market developments 2. On the inflation side, a. We know that the adjustment process by which a turnaround in trade comes about necessarily means higher import prices and upward pressure on our domestic inflation rate b. But, again, recent developments seem to have reduced inflation psychology--at least a little E. This tradeoff between economic growth and inflation, of course, represents the perennial and pivotal policy issue faced by economic policymakers such as myself F. What I want to do today is first comment on recent developments and then turn to some of the longer-term issues facing monetary policymakers https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 3 Slide #2 -- Chart: S&P 500 Stock Price Index (monthly) 11. The most significant recent development is one you are all well aware of A. Stock prices here, as well as in other countries, fell sharply in mid-October -- tremendous surprise B. We all knew market was "too high" -- that we were due for some correction -- size of drop still a surprise C. Hard to identify any single event as cause, but that's not too important 1. August merchandise trade numbers released Oct. 14 given a lot of blame, number terribly disappointing 2. Treasury Secretary Baker's comments about the dollar 3. Some people think deriviative markets, program trading, and the like caused or contributed 4. At least in part seems somehow related to our https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis inability to come to grips with imbalances in our international position and our federal budget deficits https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 4 a. Two issues that I'll talk about later b. These imbalances set us up for correction c. Until they are fixed, we will still be vulnerable 12/2/87 Policy ~emarks Page 5 Slide #3 -- Text Slide: Long-run/Short-run Monetary Policy Concerns 111. But, whatever the reason, the fall and volatility in stock prices meant a significant shift in the current thrust of monetary policy A. This shift highlights the longer-run as well as shorter-run concerns of monetary policy B. Over the long-run, monetary policy is concerned with achieving an appropriate balance between economic growth and inflation C. In the shorter-run, when events such as the stock market drop occur, monetary policy appropriately must be concerned with maintaining the integrity of the financial system f/v.." fr(., -/?ti ~ 10/ 1. Fed's role as "lender of last resort" 2. If 1929 taught us anything, we know the importance https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ( LJ of pursuing policies that prevent instability in the stock market from spreading to the rest of the financial system -- particularly the banking system ,c, - '6"<)o 12/2/87 Policy ~emarks Page 6 Slide #4 -- Text: Fed's 10/20/87 Statement IV. The Federal Reserve's response to the stock market drop was quick and, I believe, successful in containing the problems A. Following the historic 508 point drop in the Dow Jones industrial average on Monday October 19, and before U.S. stock markets opened on Tuesday October 20 B. Chairman Greenspan released the following statement: C. "The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." D. Brief statement -- but highly effective E. Received very positively by the markets https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks • Page 7 Slide #5 -- Text: Federal Reserve Response V. In support of this position -- since mid-October A. We've provided a very ample supply of reserves to the banking system through our open market operations 1. We've been in the market virtually every day 2. Often earlier than the usual "Fed Time" 3. Buying sizable amounts of securities 4. A process that adds liquidity to the banking system B. If needed, our discount window facilities are ready to accommodate the needs of the financial system C. We extended our wire transfer hours to facilitate the huge transfers of funds associated with stock market activity D. We've been in constant contact with market participants in order to assess developments as they occur E. Our monitoring activities have not been solely on financial markets -- also goods markets https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 8 1. We've also stayed in touch with those in the business community to determine the extent of financial market developments on spending plans and current situation 2. Your views -- survey forms -- one insights w::.f::~ g:/" /}J~ p()Y\lc.. , . . .__..,.·1 F. I can assure you that we will continue to provide sufficient liquidity until confidence has been restored and financial markets have been stabilized G. But, once this storm has passed, 1. Then monetary policy will need to once again refocus on its longer-term goals 2. And, the challenges facing monetary policy prior to https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis the stock market fall will once again be before us. 12/2/87 · J Policy Remarks ~Page9 Slide #6 -- Text Slide: Globilization of U. S. Economy VI. The events surrounding the stock market collapse illustrate clearly what I consider to be perhaps the most significant change we've seen over the past few years A. The "Globilization" or "Internationalization" of the U.S. economy and our financial markets B. Over the past few years we have become increasingly cognizant of the interdependencies between the U.S. economy and the economies of the rest of the world 1. This has become apparent in the growing importance of trade flows for the health of our own economy as well as the health of other economies 2. It has become apparent as well in our growing reliance on funds from abroad and resulting closer connections among financial markets worldwide 3. And with this interdependence of trade and financial https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis flows, the need for policy coordination between the U.S. and other countries has never been greater 12/2/87 Policy Remarks Page 10 C. U.S. policymakers cannot consider only domestic issues 1. Must be aware of the implications of our actions for the rest of the world 2. Must be aware of the implications for us of actions taken abroad Slide VII. # 7 -- Text Slide: Leveraging of America A second major change might be called the "Leveraging of America." Over the past few years there has been an enormous buildup of debt across all sectors of our economy. A. Debt of the Federal government as well as state and local governments has grown at an extremely rapid pace. B. Debt-to-income ratios for U.S. households are near record high levels. C. Corporate debt-to-net worth ratios are also historically high. D. And, as a nation, we are now the largest debtor country in the world. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 11 Slide #8 -- Text Slide: Major Economic Imbalances VI 11. Related to these two major changes in the economy -- the globilization and the leveraging of America A. Are two major imbalances in our economy -- often referred to as the "twin deficits" 1. Large international trade deficits which are symptomatic of the globilization process 2. Large federal government budget deficits and resulting rapid federal government debt growth -- a prime example of the leveraging of America B. Obvious that there are many issues related to these twin deficits 1. Can't discuss them all in detail 2. But to understand position of monetary policy https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis a. Important to be aware of broad dimensions of these imbalances 12/2/87 Policy Remarks Page 12 Slide #9 -- Transition Slide: International Trade Imbalance IX. To begin, let us consider our international trade imbalance Slide #10 -- Chart: U. S. Current Account X. All of you are well aware of the fact that we've had enormous international trade deficits over past few years A. This chart -- showing our current account balance, which is our broadest measure of U.S. trade performance demonstrates the magnitude of that imbalance B. Until the past few years, we traditionally had current account surpluses 1. That is, our merchandise and service exports plus our investment income receipts exceeded our imports of goods and services plus our investment payments to foreigners C. Over past 25 years 1. Relatively small current account deficits occurred https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis first in 1971 ($1.4 billion) and 1972 ($5.8 billion) 12/2/87 Policy ~emarks Page 13 2. Somewhat larger deficits in 1977-78 (both $15 billion) 3. Very sizable current account deficits since 1982 a. Deficit last year at record $141.4 billion b. First half of 1987, at annual rate of $155.8 billion 4. Fallen like a stone 5. Third quarter -- July, August, September -- numbers https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis on our merchandise trade deficit (part of current account figures) -- still very disappointing a. Note: October merchandise trade figures due Thursday, December 10 12/2/87 Policy ~emarks Page 14 Slide #11 -- Chart: Current Account vs. Foreign Capital Inflow XI. There's a counterpart to our trade deficit we must recognize A. Namely, that what happens to our current account balance is equal to what happens to our foreign capital flows 1. If we run a current account surplus, then we are net exporters of capital 2. On the other hand, when we run current account https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis deficits, we become net importers of capital 12/2/87 Policy Remarks Page 15 Slide #12 -- Chart: Net International Investment Position of U.S. X 11. And, the magnitude of our recent current account deficits and corresponding foreign capital inflows means that in five short years we have gone from being the largest creditor nation to being the largest debtor nation in the world A. Now this position in not inherently wrong, if funds are used for productive purposes which generate the repayment capacity to service the debt B. It is wrong to use the funds for consumption purposes -and unfortunately that basically is what has happened https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 16 Slide #13 -- Chart: U.S. Imports and Exports: Nominal XIII. When we look at what's happened to the nominal or current dollar value of our imports and exports of goods and services since the dollar began falling in early 1985 A. We see that despite the fall in the value of the dollar, progress toward solving our international trade imbalance has been painfully slow B. The dollars spent by foreigners on goods and services we export have increased since the second quarter of 1986 1. After changing little on balance from 85Q1 to 86Q2 2. Dollar value of goods and services exported has risen at a compounded annual rate of 13.4% C. But, the dollar amount we've spent on imported goods and services has continued to climb at a rapid clip 1. After 8.2% annual rate rise from 85Q1 to 86Q2 2. Picked up to 13. 7% annual rate from 86Q2 to 87Q3 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 17 Slide #14 -- Chart: U.S. Imports and Exports: Real XIV. If we adjust for price changes, and look at the volume or quantity of goods and services traded A. The picture is somewhat more promising B. On the export side the story is similar to what's happened to the dollar value of goods and services purchased by foreigners 1. After changing little on balance from 85Q1 to 86Q2 2. The quantity of goods and services we exported rose at an annual rate of 13.4% from 86Q2 to 87Q3 C. On the import side, 1. After climbing at an annual rate of 13% from 85Q1 to 86Q3 2. We saw a slight drop in the quantity of goods and services imported from 86Q3 to 87Q1 a. Had raised hopes that the turnaround was here 3. But, since 87Q1, the quantity of imports has once https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis again risen rapidly--at an annual rate of 13.6% 12/2/87 Policy Remarks Page 18 Slide #15 -- Chart: U.S. Net Exports: Nominal vs. Real XV. The net result -- still large deficits in our net exports of goods and services (the difference between exports and imports): A. The nominal or current dollar value of our net exports has continued to deteriorate B. The real value = quantity of our net exports 1. Which had shown signs of improving over the 86Q3 to 87Q1 period 2. Leveled off in 87Q2 and 87Q3 C. We remain confident that our trade situation will turn around, but that turnaround is taking much longer than expected D. In the meantime, given the fact that our trade deficit is intrinically tied to our foreign capital inflows 1. Our reliance on foreign funds will continue until we https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis have a turnaround in the dollar value of our international trade deficit 12/2/87 Policy Remarks Page 19 Slide #16 -- Transition Slide: Federal Budget Imbalance XVI. But, we have a second major imbalance in our economy that complicates our ability to solve our international imbalance A. That imbalance is our federal budget deficit B. Must correct the federal budget imbalance between spending and revenues C. Efforts to reduce the federal budget deficit must continue D. At a minimum, Congress must act to implement budget summit agreement announced November 20 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 20 Slide #17 -- Chart: Federal Deficit as a % of GNP XVII. Federal budget deficits of current magnitudes at this stage of the economic expansion are unprecedented A. Not at all unusual at the the time of recession or other adverse events 1. Indeed, many programs are specifically designed to ease the pain of recessions B. But we just completed the 5th year of the current economic expansion and until just recently we were running deficits around 4-1/2 to 5% of GNP 1. Unfortunately, large part of recent drop is temporary, due to large tax payments from last year's tax law changes 2. Deficit as a percent of GNP more likely to rise than fall in coming years if efforts to reduce the deficit stall/fail 3. We've never done this before https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 21 Slide #18 -- Chart: Total Gross Public Debt XVII I. Federal deficits result in Treasury debt A. Rising at an alarming rate B. Debt level in early 1975, $500 billion C. Was $2.4 trillion at end of November 1. That's about $9,800 for each man, woman, and child living in the United States! D. And, even with the $30 billion deficit cut agreed to on November 20 -- assuming it's enacted -- we'll still have a deficit of around $150 billion in fiscal 1988 1. That means about $600 million in new money, on average, needs to be raised each business day 2. Nearly $3 billion per week https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 22 Slide #19 -- Chart: Interest on Debt XIX. Interest on the debt has to be paid A. Growingly worried about compound interest syndrome 1. Is this an issue that has gotten beyond our control? 2. Interest on the debt is assuming a much larger position in the annual budget -- 10% in fiscal 1976, 19-1/2% in fiscal 1987 3. Even on this basis alone, the need for action on the deficit is very compelling B. But, implications of continued high federal budget deficits go further 1. At stake -- whole issue of allocation of savings and investment dollars between government and private sector 2. Of particular concern is that interest rates are https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis higher as a result of budget deficit a. Some debate on this issue 12/2/87 Policy Remarks Page 23 Slide #20 -- Chart: Uses of Total Available Savings XX. But when we look at how available savings have been used A. Large proportion soaked up by Federal deficits 1. Total available savings averaged 10% of GNP from 1984 to 1986 -- historically high a. At about 8-1/2% in first three quarters of 1987 -- around norm of 1970s, early 1980s 2. Federal deficit as % of GNP: 5.2% in 1983 4.5% in 1984 4.9% in 1985 4.8% in 1986 3.3% in first 3 quarters of 1987 Record high percent for this stage of expansion B. It is only logical then that there has been pressure on interest rates from the deficit 1. And private domestic investment squeezed out by https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis those higher interest rates 12/2/87 Policy ~emarks Page 24 Slide #21 -- Chart: Sources of Total Available Savings XXI. Would have been worse if we didn't have foreign capital inflow A. Foreign capital inflow augmented our domestic savings 1. On annual average basis, domestic savings (=personal savings + undistributed corporate profits + state and local government surpluses) since 1970 ranged from low of 6.5% of GNP in 1986 to 9.9% in 1973 a. Was only 5% in first 3 quarters of 1987 2. Domestic savings, which accounted for virtually all of total available savings in 1982, provided only a. Two-thirds of total last year (1986) b. Less than 60% so far this year (1987) 3. Savings from abroad provided the remainder B. But, the expected turnaround in our international trade deficit necessarily means that the amount of foreign capital coming into our country will be reduced https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 25 C. One plus from the recent stock market events was more serious budget negotiations between Congress and the President 1. I view this as fortunate even though smaller budget deficits mean less fiscal stimulus for economic growth 2. It's fortunate because recent trends do not point to https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis an increase in our own domestic savings relative to our investment needs 12/2/87 Policy Remarks Page 26 Slide #22 -- Chart: Domestic Savings vs. Investment (as a % of GNP) XXII. As we can see on this chart, the margin or difference between domestic savings and domestic investment has been narrowing over the past few years A. As in our earlier chart, domestic savings includes personal savings, undistributed corporate profits, and state and local government budget surpluses 1. Although the margin had been narrowing, as a percent of GNP, our domestic savings still exceeded our domestic investment -- until this year 2. First 3 quarters of 1987, domestic savings fell short of our investment needs by 0.1 % of GNP 3. And, don't forget, we still had a federal budget deficit exceeding 3% of GNP to finance B. As we see in this chart, the primary cause of the savings/investment imbalance is the fall in savings side 1. And, that largely reflects what's happened to our https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis personal savings rate 12/2/87 Policy Remarks Page 27 Slide #23 -- Chart: Personal savings as % of disp. personal income XXII I. This chart shows what's been happening to our personal savings rate A. Personal savings as a percent of disposable personal income has been well below 1960-1981 average of 7-1/4% during most of the current expansion 1. The 4.3% savings rate reported for all of 1986 was the lowest since 1949 a. And, we've had about a 3-1/2% savings rate so far in 1987 B. What this means is that the consumer is not providing sufficient savings needed for both domestic investment and to finance the budget deficit https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 28 Slide #24 -- Chart: Cons. Installment Debt as % of Disp.Pers.lncome XXIV. Rather, the consumer has been on a spending spree, and to a large extent supported that spending spree by taking on huge amounts of debt -- part of the leveraging of America problem A. Consumer installment debt has risen to record levels relative to disposable personal income B. Although there are some mitigating circumstances which moderate the sheer magnitude of numbers 1. Increased use of credit cards for managing cash -included in figures though fully repaid each month 2. Demographics -- higher percentage of population in age groups that are typically borrowers 3. Longer-maturity loans imply lower monthly payments 4. More-than-offsetting increases in assets (a) Although stock market drop changed that somewhat C. Nonetheless, personal debt loads have become very heavy 1. Raises the question as to the sustainability of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis consumption and, therefore, the economic expansion 12/2/87 Policy Remarks Page 29 2. Will consumers be able to handle this debt if personal incomes begin to fall? D. And yet another disturbing aspect, while recent consumer debt-to-income ratio has leveled off (fallen) somewhat 1. Partially due to tax law changes and resulting shift to using home equity loans not included in the consumer installment debt figures 2. Not sure the consumer fully aware of the risks https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis should economic situation turn sour. vJ~ 12/2/87 Policy ~emarks Page 30 Slide #25 -- Chart: Funds Raised by Nonfinancial Corporate Business XXV. The consumer has not been alone in the increasing debt load picture A. Corporate debt in the U.S. also has increased sharply over the past few years 1. In 1984, consolidated corporate debt issued by nonfinancial corporations amounted to $196 billion -- a record 2. At $167 billion in 1985 and $192 billion in 1986, we saw the second and third largest amounts ever recorded. 3. Drop in first half of 1987 to $91 billion annual rate still represents significant increase B. Much of that debt used to finance the extraordinary pace of mergers, leveraged buyouts, share repurchases and other restructuring plans of the past 3-1/2 years 1. In process, huge amounts of corporate equity retired 2. Such retirements far exceeded new issues offered https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 31 3. So that net equity issues -- the difference between new offerings and retirements -- were significantly negative in 1984, 1985, 1986, and first half of 1987 4. Corporate America has been decapitalizing itself Slide #26 -- Chart: Corporate Debt to Net Worth Ratio XXVI. As a consequence, corporate debt relative to net worth has increased sharply in past three years A. From 60-64% range observed over 1970-1983 period to about 84% in 1986 (measured on historical cost basis) B. Debt service implications if this trend continues . wornsome 1. Increased claim on future earnings means less internally generated funds available for investment 2. Debt service becomes more difficult if economy falters, if interest rates rise C. Destabilizing element -- Vulnerability https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy ~emarks Page 32 Slide #27 -- Text Slide: Policy Implications XXVI I. These imbalances clearly have important implications for U.S. economic policies A. Not just monetary policy 1. Indeed, monetary policy alone cannot directly address these major imbalances B. Implications for fiscal policy as well 1. Clearly, Congressional actions determine budget and trade policies 2. And we know that savings and investment decisions are significantly affected by government spending and taxing policies C. In making monetary policy, these imbalances and course taken by fiscal policy must be taken into consideration 1. They are an important part of the environment 2. And influence what monetary policy can do in https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis affecting the economy 12/2/87 Policy Remarks Page 33 Slide #28 -- Chart: Federal Budget Deficit Outlook XXVIII. The importance of federal budget imbalance is quite obvious A. U.S. fiscal policymakers should be seeking a better balance between federal government spending and revenues B. In other words, they should continue to move toward reducing the federal budget deficit C. Results for fiscal 1987 were quite good 1. Budget deficit was "only" $148 billion, down sharply from $221 billion in FY86 2. However, much of that improvement reflected higher tax revenues from capital gains taken in late 1986 -- a one-time change due to Tax Reform D. Without further fiscal policy changes, budget deficit would rise over the next two fiscal years 1. FY88: $161 billion (0MB) vs. $183 billion (CBO) 2. FY89: $166 billion (0MB) vs. $192 billion (CBO) E. And, even assuming that the November 20 budget summit agreement is fully implemented https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 34 1. Impact, based on CBO forecast, would be deficits still about $150 billion in fiscal 1988 and 1989 F. And, if we don't get smaller deficits 1. Additional upward pressure on interest rates since that deficit must be financed 2. Less savings available for our private investment 3. Continued heavy reliance on savings from abroad G. In other words, if the federal budget deficit is not reduced, we will continue to have a tough time dealing with other imbalances in our economy https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 35 Slide #29 -- Chart: Domestic Spending vs. Output XXIX. To a large extent, the significance of the international imbalances for the U.S. economy can be summarized in this chart A. Which shows our domestic spending (Gross Domestic Purchases) as a percent of our domestic output (GNP) B. Over the past several years we've been spending far more than we've been producing 1. The difference between our spending and output reflects our net export position 2. That is, the excess of goods and services we've imported over those we've exported C. If we were to look at comparable data for our trading partners 1. We'd see just the opposite situation 2. Since, by definition, our trade deficit must be https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis reflected in trade surpluses of our trading partners taken collectively 12/2/87 Policy ~emarks Page 36 3. This means that, in the aggregate, they've been https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis producing more than they've been spending in order to meet demands for goods and services from the U.S. 12/2/87 Policy Remarks Page 37 Slide #30 -- Chart: Trade weighted dollar XXX. With the decline in the foreign exchange value of the dollar A. The production and spending relationships are being changed 1. We will need to produce more and spend less 2. Foreigners will have to spend more and produce less B. The lower dollar 1. Brings about a rise in our net exports and a fall in net exports of our trading partners 2. This translates into higher real GNP growth for us but lower real GNP growth for other nations C. But the lower dollar also affects inflation 1. As prices on goods we import rise, that means that our inflation is higher than otherwise 2. For other nations, as the price of goods we export https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis to them falls, that means their inflation is lower than it would have been 12/2/87 Policy Remarks Page 38 D. A "Catch-22" or a policy dilemma for us 1. While we would all like to have more economic growth 2. Is higher inflation the price we want to pay E. The policy dilemma for other nations 1. Lower inflation may be desirable 2. But is lower economic growth a price they can afford F. And in turn for us 1. If other nations have lower growth, can we expand https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis our exports to them 12/2/87 Policy ~emarks Page 39 Slide #31 -- Text Slide: Domestic Policy Goals XXXI. In final analysis, the primary objective of monetary policy A. Is to achieve maximum growth with price stability -- to balance these goals 1. Don't want more growth at the cost of inflation a. It doesn't buy anything in the long run 2. But we certainly want as much growth as we can get without price escalation B. This view of what monetary policy seeks in the longerrun is not inconsistent with what we might do in the short-run 1. Because of the fall in the stock market 2. Because of what might be happening to the foreign exchange value of the dollar C. Such events have implications 1. For economic growth 2. For inflation https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 40 D. And if such events move us away from balance between economic growth and inflation 1. Then our monetary policy must be adjusted accordingly E. In a longer-run perspective, the real question is what growth is attainable 1. Currently, the twin deficits -- the federal budget https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis deficit and the trade deficit -- are the major constraints to greater growth a. They may both be declining, or we hope they will, but their legacy is still with us b. We are paying the costs of our excesses c. Consequently, we may not be able to achieve much more rapid growth now 12/2/87 Policy ~emarks Page 41 Slide #32 -- Chart: Real GNP, Actual and Trend XXXII. In spite of imbalances in our economy, we are running close to our long-term growth path A. On this chart we show actual real GNP and its trend over the past four decades and trend over past 20 years 1. Over 40-year period, growth in real GNP averaged 3% a. But 3-1/2% trend growth from 1947-1966 b. And 2-1/2% trend growth since 1967 2. So, while somewhat below 40-year trend path a. We're very close to 67-87 trend path B. So, while recent stock market developments appropriately called for a more accommodative monetary policy response 1. We can't expect to continue such a stance forever C. At some point, attempts to achieve more rapid growth 1. Will run some risks to long-term price stability 2. Especially since we're already under price pressures https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis from imports https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12/2/87 Policy Remarks Page 42 a. If these pass through to other products and to wage rates generally b. Could get a systematic increase in inflation c. To longer-term detriment of economic growth 12/2/87 Policy ~emarks Page 43 Slide #33 -- Chart: Consumer Prices XXXIII. The key challenge for monetary policymakers over the near future will be determining A. When sufficient liquidity has been supplied to assure economic growth continues 1. Without sacrificing the progress we've made on the inflation side B. From my perspective, it's essential that U.S. monetary policymakers remain aware that the balance between our economic growth and our inflation is very important 1. The history of our inflation shown here by the year- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis to-year rate of change in consumer prices indicates that a. We've had good price performance in the last few years b. But, it wasn't so long ago that inflation was in the double-digits 12/2/87 Policy ~emarks Page 44 c. The primary reason was unsustainably high economic growth d. To correct that imbalance in the past meant recession e. That need not be the case now C. Once the current market situation has been stabilized, we can continue to see good economic growth with price stability 1. Provided that we remain aware of the implications for our economic growth and inflation of actions taken by other policymakers a. And work together to correct imbalances 2. Provided that we recognize that the recent rise in https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis our inflation from higher import prices can be only a temporary increase -- a necessary part of the adjustment process in correcting our international imbalance 12/2/87 Policy Remarks Page 45 3. Provided that we remain alert to, and respond https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis appropriately to, the potential for these temporary price pressures being built permanently into our price structure a. From domestic producers raising prices unduly b. From wage increases that exceed productivity . gams 12/2/87 Policy Remarks Page 46 Slide #34 -- FRB Chicago Logo XXXIV. Concluding Remarks A. Tried to show economic environment very different 1. From few months ago a. Stock market fall b. Monetary policy response 2. From few years ago ~ ~ ' a. Globilization / buildup of debt b. Imbalances B. Monetary policy record good 1. Market stability apparently restored 2. Excellent economic results likely to continue 3. Inflation - higher - but not unreasonable 4. Challenge - maintain growth rate - but don't let inflation rise to an unacceptable level 5. Every expectation we'll continue this record https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • • • • •