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Silas Keehn: Monetary Policy Remarks
July 1988 Iowa Economic Forums
7 /11/88 -- Storm lake, IA (p.m. reception)
7/12/88 -- Sioux City, IA (breakfast}
7/12/88 -- Red Oak, IA (p.m. reception)
7/5/88
Slide #1 -- Title Slide: Challenges for Monetary Policy
I.
Outlook Karl just gave one that I consider to be fairly good
outcomes for economic growth and inflation, especially since
we are now well into the 6th year of the current expansion
A.
But achievement of our economic growth outlook is highly
dependent on a turnaround in our international trade
B.
Moreover, adjustment process by which that turnaround in
trade comes about necessarily means higher import prices
and upward pressure on our domestic inflation rate
C.
This tradeoff between economic growth and inflation, of
course, represents the perennial and pivotal policy
issue faced by economic policymakers such as myself
D.
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But our decisionmaking process has become more
complicated because the economy we live in today is very
different from that of just a few years ago
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Slide #2 -- Text Slide: Globilization of U. S. Economy
11.
Perhaps the most significant change we've seen is what can
be called the "Globilization" or "Internationalization" of
the U.S. economy and our financial markets.
A.
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
flows, the need for policy coordination between the
U.S. and other countries has never been greater
B.
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U.S. policymakers cannot consider only domestic issues
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Page 3
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 #3 -- Text Slide: Leveraging of America
111.
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 at 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.
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Slide #4 -- Text Slide: Major Economic Imbalances
IV.
Related to these two major changes in the economy -- the
globilization and the leveraging of America
A.
Are two major imbalances in our economy
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 related issues
1.
Can't discuss them all in detail
2.
But to understand position of monetary policy
a.
Important to be aware of broad dimensions of
these imbalances
Slide #5 -- Transition Slide: International Trade Imbalance
V.
To begin, let us consider our international trade imbalance
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Slide #6 -- Chart: U. S. Current Account
VI.
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.
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But, since 1982 we've had increasingly larger and larger
current account deficits
1.
Deficit last year at record $154 billion
2.
First quarter of 1988, at annual rate of $159
billion
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Slide
VI I.
#7
-- Chart: Current Account vs. Foreign Capital Inflow
There's a counterpart to our trade deficit we must recognize
A.
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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
deficits, we become net importers of capital
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Slide #8 -- Chart: Net International Investment Position of U.S.
VII I.
And, the magnitude of our recent current account deficits
and corresponding foreign capital inflows means that
A.
In just a few years we have gone from being the largest
creditor nation to being the largest debtor nation in
the world
1.
l
Now this position in not inherently wrong, if funds
are used for productive purposes which generate the
I
l
repayment capacity to service the debt
2.
It is wrong to use the funds for consumption
purposes -- and unfortunately that basically is what
has happened
B.
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The deterioration in our net international position, of
course, means that the amount of U.S. assets that
foreigners hold is now greater than the amount of
foreign assets that we hold
1.
And that development has implications for what is
referred to as U.S. balance on services
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Slide #9 -- U.S. Balance on Goods and Services
IX.
Two stories emerge when we look at the Goods and Services
components of the total U.S. balance on goods and services
A.
The Goods balance--essentially our merchandise trade
position--shows deficit picture we're all familiar with
1.
Significant deterioration in recent years
2.
Some improvement recently as indicated by latest
reports on our merchandise trade deficit
B.
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But until this year's first quarter, a surplus in our
balance on services offset part of the deficit on goods
1.
Balance on services is dominated by difference
between our income receipts on assets held abroad
and income payments on U.S. assets held by
foreigners
2.
In this year's first quarter, our receipts from
foreigners were less than our payments to foreigners
3.
Although differential rates of return can lead to
quarter-to-quarter fluctuations in this situation
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4.
With the foreign-owned capital base in the U.S.
continuing to get larger, the likelihood for further
deterioration in our balance on services increases
Slide #10 -- Chart: U.S. Net Exports: Nominal vs. Real
X.
But, we are--in a quarterly GNP sense--seeing, and expect to
continue seeing, improvement in our net exports
A.
The real value or quantity of our net exports has shown
signs of improvement since the third quarter of 1986
1.
B.
Provided boost to our real GNP growth
The nominal or current dollar value of our net exports
finally turned around in this year's first quarter
C.
We remain confident that improving trends will continue
D.
But, given the fact that our trade deficit is
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intrinically tied to our foreign capital inflows
1.
The inflow of foreign funds will be reduced as the
nominal dollar value of our international trade
deficit narrows
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Slide #11 -- Transition Slide: Federal Budget Imbalance
XI.
But, we have a second major imbalance in our economy that
complicates the adjustment process as we return to better
balance in our international trade position
A.
That imbalance is our federal budget deficit
B.
Must correct the federal budget imbalance between
spending and revenues
C.
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Efforts to reduce the federal budget deficit must
continue
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Slide #12 -- Chart: Federal Deficit as a % of GNP
X 11.
Federal budget deficits of current magnitudes at this stage
of the economic expansion are unprecedented
A.
Not unusual at time of recession or other adverse events
1.
Indeed, many programs are specifically designed to
ease the pain of recessions
B.
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But we're now well into the 6th year of the current
economic expansion and until just recently we were
running deficits around 4-1/2 to 5% of GNP
1.
But, large part of last year's drop temporary, due
to large tax payments related to 1986 tax changes
2.
And growing surplus in Social Insurance Funds makes
recent figures appear better than they really are
a.
In 88Q1, total deficit
= 3.1 % of GNP;
deficit
excluding Social Insurance Fund surplus
3.
= 4%
Deficit as a percent of GNP more likely to rise than
fall in coming years if efforts to reduce the
deficit stall/fail
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Slide #13 -- Chart: Gross Public Debt of U.S. Treasury
X 111.
Federal deficits result in Treasury debt
A.
Rising at an alarming rate
B.
Debt level in early 1975, $500 billion
C.
More than $2.5 trillion at end of June
1.
That's over $10,000 for each man, woman, and child
living in the United States!
D.
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And, even if the deficit comes in around $150 billion
this year--and many expect it to be higher
1.
That means at least $600 million in new money, on
average, needs to be raised each business day
2.
$3 billion per week
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Slide #14 -- Chart: Total Interest on Debt
XIV.
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.
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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
higher as a result of budget deficit
a.
Some debate on this issue
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Slide #15 -- Chart: Uses of Total Available Savings
XV.
But when we look at how available savings have been used
A.
Large proportion soaked up by Federal deficits
1.
2.
Federal deficit:
% of GNP
1983
5.2
62.5
1984
4.5
40.5
1985
4.9
49.0
1986
4.8
48.9
1987
3.4
38.8
1988-Ql
3.1
34.6
% of total savings:
After more than 5 years of expansion, still over
one-third of total available savings being used to
finance deficit
B.
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It is only logical then that there has been pressure on
interest rates from the deficit
1.
And private domestic investment squeezed out by
those higher interest rates
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Slide #16 -- Chart: Sources of Total Available Savings
XVI.
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 5.2% of GNP in 1987 to 9.9% in 1973
a.
2.
Was only 5.6% in first quarter of 1988
Domestic savings, which accounted for virtually all
of total available savings in 1982, provided only
3.
B.
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a.
60% of total last year {1987)
b.
64% in first quarter of 1988
Savings from abroad provided the remainder
But, turnaround in our international trade deficit
necessarily means that the amount of foreign capital
coming into our country is being reduced
1.
Becoming evident in first quarter of this year
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C.
In the aftermath of the stock market events of last
October we saw more serious budget negotiations between
Congress and the President
1.
Unfortunately, those efforts have recently stalled
2.
Although smaller budget deficits mean less fiscal
stimulus for economic growth
3.
With less foreign capital coming into this country
as our trade imbalance turns around, further budget
deficit reduction efforts are necessary because
recent trends do not point to a significant increase
in our own domestic savings relative to our
investment needs
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Page 17
Slide #17 -- Chart: Domestic Savings vs. Investment (as a % of GNP)
XVII.
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 last year
2.
In 1987 and first quarter of 1988, domestic savings
fell short of our domestic investment needs
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
personal savings rate
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Policy Remarks
Page 18
Slide #18 -- Chart: Personal savings as
XVIII.
% of disp. personal income
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 3. 7% savings rate reported for all of 1987 was
the lowest since 194 7
2.
And, while up to almost 4-1/2% so far in 1988, still
historically low
B.
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What this means is that the consumer is not providing
sufficient savings needed for both domestic investment
and to finance the budget deficit
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Slide #19 -- Chart: Cons. Installment Debt as % of Disp.Pers.lncome
XIX.
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
C.
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3.
Longer-maturity loans imply lower monthly payments
4.
More-than-offsetting increases in assets
Nonetheless, personal debt loads have become very heavy
1.
Raises the question as to the sustainability of
consumption and, therefore, the economic expansion
2.
Will consumers be able to handle this debt if
personal incomes begin to fall?
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D.
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And yet another disturbing aspect, while rise in
consumer debt-to-income ratio has slowed 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
should economic situation turn sour
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Slide #20 -- Chart: Funds Raised by Nonfinancial Corporate Business
XX.
Consumer not 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.
And, amounts raised through debt instruments since
then have remained historically large
B.
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Much of that debt used to finance the extraordinary pace
of mergers, leveraged buyouts, share repurchases and
other restructuring plans of past several years
1.
In process, huge amounts of corporate equity retired
2.
Such retirements far exceeded new issues offered
3.
So that net equity issues -- the difference between
new offerings and retirements -- have been
significantly negative since 1984
4.
Corporate America has been decapitalizing itself
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Slide #21 -- Chart: Corporate Debt to Net Worth Ratio
XXI.
As a consequence, corporate debt relative to net worth has
increased sharply in recent years
A.
From 60-64% range observed over 1970-1983 period to
about 92% in 1987 {measured on historical cost basis)
B.
Debt service implications if this trend continues
worrisome
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.
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Destabilizing element -- Vulnerability
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Policy Remarks
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Slide #22 -- Text Slide: Policy Implications
XXII.
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.
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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
affecting the economy
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Slide #23 -- Chart: Federal Budget Deficit Outlook
XXIII.
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, reduce the federal budget deficit
C.
Results for fiscal 1987 were relatively good
1.
Budget deficit was "only" $150 billion, down sharply
from record $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.
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The outlook for this fiscal year and next may not even
be as favorable as shown on this chart
1.
In projections made last spring, assuming adoption
of President's fiscal 1989 budget that fully
incorporates the $46 billion fiscal 1988-89 deficit
reductions agreed to by the Administration and
congressional leaders late last year
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2.
0MB expected the budget deficit to continue falling
this fiscal year and next while CBO saw it rising
E.
a.
FY88: $147 billion (0MB) vs. $161 billion (CBO)
b.
FY89: $130 billion (0MB) vs. $165 billion (CBO)
But Congress has not yet passed the neccessary fiscal
1989 appropriations bills
1.
And, 0MB Director James Miller said in mid-June that
if deficit projections were made then, fiscal 1989
would be closer to $150 billion than $130 billion
F.
If this happens and we don't get smaller deficits
1.
Additional upward pressure on interest rates since
that deficit must be financed
G.
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2.
Less savings available for our private investment
3.
Continued heavy reliance on savings from abroad
In other words, if the federal budget deficit is not
reduced further, we will continue to have a tough time
dealing with other imbalances in our economy
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Slide #24 -- Chart: Domestic Spending vs. Output
XXIV.
To a large extent, significance of the international
imbalance for the U.S. economy 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.
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If we looked at comparable data for our trading partners
1.
We'd see just the opposite situation
2.
Since, by definition, our trade deficit must be
reflected in trade surpluses of our trading partners
taken collectively
3.
This means that, in the aggregate, they've been
producing more than they've been spending in order
to meet demands for goods and services from the U.S.
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Slide #25 -- Chart: Trade weighted dollar
XXV.
With the decline in the foreign exchange value of the dollar
A.
The production and spending relationships are being
changed
B.
1.
We will need to produce more and spend less
2.
Foreigners will have to spend more and produce iess
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.
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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
to them falls, that means their inflation is lower
than it would have been
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Page 28
D.
E.
F.
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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
The policy dilemma for other nations
1.
Lower inflation may be desirable
2.
But is lower economic growth a price they can afford
And in turn for us
1.
If other nations have lower growth, can we expand
our exports to them
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Slide #26 -- Gross Foreign Capital Inflow
XXVI.
Policy dilemma for other nations further complicated by fact
that movements in the dollar in recent years supported by
coordinated intervention actions by central banks
A.
As a result, a significant part of gross foreign capital
inflows into U.S. has been in the form of foreign
official rather than foreign private funds
1.
Most of foreign official represents acquisition of
U.S. Treasury securities
2.
From end of 1985 to end of 1988-Q1, over $100
billion of U.S. Treasury securities acquired by
foreign officials--20% of increase in Gross Public
Debt of U.S. Treasury over this period
B.
Ability of foreign central banks to offset intervention
impact on their domestic economies has been limited
C.
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In other words, their ability to maintain their domestic
economic growth in a noninflationary environment made
more difficult because of trade and federal budget
imbalances in the U.S.
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Slide #27 -- Text Slide: Domestic Policy Goals
XXVI I.
Therein lies crux of the problem because, in final analysis,
whether we're talking about the U.S. or other nations
A.
Primary objective of monetary policy is to achieve
maximum growth with price stability--to balance these
goals
1.
Don't want more growth at the cost of inflation
a.
2.
It doesn't buy anything in the long run
But we certainly want as much growth as we can get
without price escalation
B.
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The real question is what growth is attainable
1.
Currently, our trade and federal budget imbalances
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
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Slide #28 -- Chart: Real GNP, Actual and Trend
XXVIII.
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.
2.
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
So, while somewhat below 40-year trend path
a.
B.
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We're very close to 67-88 trend path
Attempts to achieve more rapid growth
1.
Run some risks to long-term price stability
2.
Especially since we're already under price pressures
from imports, relatively high capacity utilization
rates in some industries
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
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Page 32
Slide #29 -- Chart:
XXIX.
Consumer Prices
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
A.
The history of our inflation shown here by the yearto-year rate of change in consumer prices indicates that
1.
We've had relatively good price performance in the
last few years
2.
But, it wasn't so long ago that inflation was in the
double-digits
3.
The primary reason was unsustainably high economic
growth
4.
To correct that imbalance in the past meant
.
recession
5.
B.
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That need not be the case now
In the current situation we can continue to see good
economic growth with price stability,
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Polic_y ~emarks
Page 33
1.
Provided that we remain aware of the implications
for our economic growth and inflation of actions
taken by other policymakers
a.
2.
And work together to correct imbalances
Provided that we recognize that recent rise in our
inflation from higher import prices can be only a
temporary increase -- a necessary part of the
adjustment process in correcting our international
imbalance
3.
Provided that we remain alert to, and respond
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
gains
7/5/88
Polic_y Remarks
Page 34
Slide #30 -- FRB Chicago Logo
XXX.
Concluding Remarks
A.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Tried to show
1.
2.
Economic environment very different
a.
Globilization / buildup of debt
b.
Imbalances
Record good
a.
Economic results excellent
b.
Inflation - higher - but not unreasonable
c.
Challenge - maintain growth rate - but don't let
inflation rise to an unacceptable level
Every expectation we'll continue this record
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