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I M P O R T A N T
SAINT LOUIS ROUND TABLE CLUB MEETING
MONDAY, APRIL 23, 1990
NOON DAY CLUB
COTTON BLOSSOM ROOM
ONE METROPOLITAN SQUARE - SUITE 4000
Cocktails:
Lunch:
Speaker:
11:45 A.M.
12:15 P.M.
THOMAS C. MELZER, PRESIDENT
FEDERAL RESERVE BANK OF ST. LOUIS
PLEASE REPLY PROMPTLY WITH FIRM COMMITMENTS
IN ENCLOSED ENVELOPE
INTRODUCTION
1990s Off to Very Strange Start
CHART 1: Federal Funds Rate and Treasury Securities
* Fed funds rate (- and unchanged) vs other
rates(+) since D e c ; very different from 1989
pattern.
CHART 2: U.S., Japanese and West German Interest Rates
* Foreign interest rates have been rising
throughout 1989 and into 1990; U.S. rates
fell for much of 1989 before rising again
since Dec.
CHART 2: Foreign Exchange Rates
* Exchange rate movements Yen/$ and DM/$ very
different in 1990 from 1989 pattern.
* Since Feb. $ up against both Yen and DM
despite major increases in foreign
interest rates.
1
CHART 4.: U.S.-German Interest Differential and DM/S
Rate
I think that the interesting aspects shown here
(the behavior in 1990) can be more easily pointed
out using the previous two charts.
What's It All About?
* For analysis of such diverse and puzzling
movements, you need a framework for analysis.
I 7 11 use one that focuses on impact of U.S.
monetary policy on the economy.
CHART 5: Ml Money Stock
* In last 5 years there has been one obvious
major change in monetary (Ml) growth: 85-86
vs. 87-present.
* 85-86 policy was intended(?) to depress
(devalue) the $ in forex markets; 87-present was
intended (?) to wring out the inflationary effects
produced by the 85-86 episode.
Both periods were
characterized by excessive policy actions (first,
2
too fast, then too slow).
* The same pattern of "excess" can be seen
more recently.
2nd half of 88-lst half of 89:
Ml growth was too slow—result: weakening
economy.
2nd half of 89 to present: Ml growth
is accelerating—possible result?:
accelerating inflation.
CHART 6: Ml Money Stock With FOMC Dissents
* Brief discussion of policy and context of FOMC
dissents.
* Why have U.S. interest rates risen recently?
For two reasons, both related to policy issues.
First, Ml growth has accelerated recently—
ADD RECENT NUMBERS—and raised inflationary
expectations.
Since expected inflation is a key
determinant of interest rates, interest rates
rose as well.
Second, the sharp swings in money growth
contribute to greater risks in financial markets
because it is increasingly difficult to
determine what sort of policy we are following.
Since such risk considerations are a key
determinant of interest rates, U.S. interest
3
rates rise.
* If things are so confused here, why has the $
risen recently?
Because, believe it or not,
things are worse abroad.
The sharp rise in
foreign interest rates have been produced by inreased inflation and inflation expectations
in Japan and Germany.
Moreover, increased
risks associated with Japanese financial markets
and German unification have pushed their rates
up as well.
When things get confused worldwide,
the $ is the usual "safe haven."
Where Do We Go From Here?
CHART 2: Rates of Growth in Ml
* Policy is now at a crossroads. The trend
(long-term) growth in Ml tells us what the
monetary pressures on inflation are likely to
be.
We've reduced this inflationary influence
significantly in recent years.
If we can
gradually reduce it further (to about 1 to 2
percent), we would approach a goal of stable
prices and win the inflation battle.
Doing so
would reduce U.S. interest rates and add to the
4
stability of U.S. financial markets. Will we
actually do it?
* We are in for a period (perhaps extended) of
slower economic growth—Partly in response to
slow Ml growth in early 1989 and partly because
what is termed the "natural" rate of real growth
is only about 2 to 2.5 percent.
If we attempt
to accelerate real growth by faster money
growth, we'll lose the inflation battle.
* There are repeated calls for further devaluation
of the $, largely in an attempt to increase our
exports.
Such attempts are usually misguided
because they fail to distinguish between
movements in real vs. nominal exchange rates.
If we attempt to drive the $ down by
faster money growth, we'll lose the inflation
battle.
* There will be increasing calls for us to "ease"
the burdens that Japan and Germany may have
to face in reducing their inflationary pressures
and other economic problems.
One way to do
this would be to "speed up" our economy to
encourage more imports from these economies.
we attempt to ease their "burdens" by faster
5
If
U.S. money growth, we'll lose the inflation
battle.
6
Federal Funds artel
Treasury Securities Yield
Percent
10.0
9.5
9.0 b
8.5
8.0
7.5
F M A M
J
J A
1989
S
O
N
D
J F M
1990
A
Irhterest
Routes
U.S., Japan,
and
West
Germany
Percent
10.0 i
6.0
5.0
4. Q I
I
I
I
F M A M
I
I
J
I
J A
1989
I
I
I
I
S
O
N
I
D
I
I
J F M
1990
1
A
FoTexgn EoccHoLTige Rates:
DM/f and
Yen/$
DM/$
2.05
Yen/$
165
1.95
155
1.85
145
1.75
135
1.65
F M A M
J J A
1989
S O N D J F M A
1990
125
U.S. rnxnvis German
Interest 8c EaccHangeRates
Percent
3.0
DM/$
2.05
2.0
1.95
1.0
1.85
0.0
1.75
1.0
F M A M J J A
1989
S O N D J F M A
1990
1.65
Money Stock (M1)
Ratio Scale
Billions of Dollars
825
775
1
\ I
\
| --:J1
1
1
725
: I
1
1
1
11
S
1
675
-'•••::'. 1 :;-i-:'
I
625
575
525
1 ill 1 M
1985
1 1) 1 1 1 1 1 11 11
1 1 1 1 1 1 1 1 1 1 1 11 11 1 1 1 1 1 1 1 l .1 1 1 1 1 1 1 1
1 1
86
87
88
1 1 1 1 1 1 1 1 1 1 1 1 I
89
1 1 1
1990
1
Money
Stock (M1)
Ratio Scale
Billions of Dollars
825
T
775
725
675
625
575
525
' la i
i i i i i i i i i i m i
1985
i i i i i i i i i
86
F0M. C JPOii-cij
i
I I I I I I IH I I
87
Di-ssent
88
89
i
i i i
i
1990
Rates of CHange of
Money Stock (M1)
Percent
20
- 4 •—
1978 79 80 81 82 83 84 85 86 87 88 89 1990
t£. a T i e T .R a, ie of Ch a, n ae
- Q ii. <x T i e T JRciie o. f Ch a ?% ge
Federal Funds and
Treasury Securities Yield
Percent
10.0
J
C 1 f;:b _
1
'_A. _i_
7~1
_i_
.mds
R at, e
9.5
.:W" + .
"-" .:.-.i:;L
9.0
8.5
-.:
8.0
-;!lrrt-.rtrEE~trrurtrrttF|
1 I-
7.5
L
,;;-*•:- { ••::; \ j ~r
l_ 1
F M A M
i
r~-*
- -
1 1 ,...1,..,
J J A
1989
~~\
' . ; -? .r
I I I
1
1 1 1
S O N D J F M A
1990
Interest
Routes
U.S., Japan,
CLIXCL
West Germouny
Percent
10.0
_*Vfc_
9.0
u
^ \ ^
-
s
8.0
_^^tm"^
West Germany
7.0
J**\
r
.".."-"^
6.0
^^=L-
5.0
4.0
:
r
_-..-;.:::=—'
L
i
i
i
F M A M
r=-=.^"--
--•-.v'-T:--
i
i
J
i
i
J A
1989
i
S
i
i
O
N
1
D
1
1
J F M
1990
|
A
Fonrexgrt EoccHctnge Rates:
DM/$ and
Yert/$
DM/$
2.05
Yen/$
165
1.95
155
1.85
145
1.75
135
1.65
F M A M
J J A
1989
S O N D J F M A
1990
125
Money
Stock (M1)
Ratio Scale
Billions of Dollars
825
i-«••>-. j . .
775
+ 1G.8%| ::: -,.
-
i . .<1
|
i
.-;;: 0 -
725
675
625
575
525
| I 1.6%
1
IB
j
1
LJ
1
• i l l
1985
i-1.1 L.J .1 .1. 1- 1 I I I I l l I l l 1 l l l J l l ]l i
86
87
88
l.i.,llJ..I_L l l I I 1 M 1 ) 1 1 1 M 1 1 1 1 1 1 ,
89
1990
Money
Stock (M1)
Ratio Scale
Billions of Dollars
825
T
775
,:.?f*^
3§fe
• 4 - : ^ <":
725
675
It- 1 1 •': /
625
575
525
» M » » i i i i i i » l i B » ) i t i i i i i l i M i i i i i i i i i l i i i i i i i » i i i l i i i
1985
86
'r- pOMC Policy
87
Dissents
88
i i i i i I i i i i i J i i i i i i
89
1990
Rates of Change of
Money Stock (M1)
i
i
i
i
)
i
i
i r-:l:."Eri i
i
i l i l
I
1 1
li
i
i
i
i
i
i
i
i
i
J
I
I
i
i
i
i
i
I
i
\
i
i
i
I
I
I
l
l
l »
1978 79 80 81 82 83 84 85 86 87 88 89 1990
*2 — Q u a, r t e r
**72—Qucirte7~
Rate
Rctte
o f Ch a -n gc
of
Change
@FedFRASER