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FRB: CLEVELAND. NS. ADDRESSES. t ^t. ll3. 'o r;J ÞJ sË tog t' Eì. :x) ít7 F3 Inflation and profits: Longer-term Perspecti ves Economic Growth, l,l. Lee Hoski ns , Pres i dent Federal Reserve Bank of Cleveland IERAL RESENW $ìIK Gr(AitsAg olTv UL I1 lEIå BEffi¡Nfi 1988 Financial 0utlook Conference The Conference Board February 24, ì988 New York Ci ty USNANV -2- in the past two decades tells us a great deal about the longer-term prospects for growth, profits and inflation. Growth and profit,s are i nextri cabìy ì i nked to i nfl ation. Durì ng the I 970s producti vi ty and Our experience i nvestment generaì ly ì agged behi nd long-establ i shed hi stori infìation accelerated. Recentìy, there deveìopments. I will c norms as have been some encouraging return to those later. is that the long-term prospects for our economy depend in a vitaì way on the environment for My message today An envi ronment characteri zed by i nfl growth and profi ts ln pri vate deci sions. ation and uncertai nty regardi ng future inflation is I ikely to retard growth and profits. In an i nfl at i on-free environment, we can achieve maximum sustainable economic growth given our resources, technoìogy and the other basic forces which contribute constrai to, or n, our long-run potenti aì . of an Inflation-Free Environment The roìe of economic poìicy, in general, ìS to The importance which private individuals can make decisions real growth and real th i s objecti profits. The that provide an env i ronment i n maximize long-term potenti aì contribution a central bank can make to ve i s to controì i nfl ati on. The proper role of monetary policy, therefore, is to maintaìn price stabi ì i ty over the long run. Thi s requì res a monetary pol i cy th a cycle. It requires a monetary consi stently mai ntai ned objecti ve of zero perspective broader than the current business policy with a cìearìy stated, wi -,3 - inflation. I for reducing inflation from its recent leveì of about four percent to zero in some reasonable period -- three believe that specifying a path to five years -uncertainty. would make a material contribution By maintaining such a poìicy, to reducing we can provide market the certainty.and stabiìity necessary to maximize our long-term potential growth. The policy ìesson from the .l970s is that an inflationary environment is not conducive to economic growth and corporate profitabiìity. Durìng the ì970s, we repeatedly shifted the focus of policy from fighting inflation fighting unemployment. The resuìt that Inflation trended was upward and reached we achieved economic processes ìong-term growth and became deeply entrenched decisions. The investment share trends, such as the flood of new neither objective. its highest peacetime level in 1979. Infìationary expectations eroded the investment to of in that generate consumption, savings GNP declined. and Demographic entrants into the ìabor force, also to the resul ti ng decl i ne i n productì vi ty growth. Long-term potentiaì growth in the United States, difficult though it may be to measure, contri buted slowed. After a decade of poìicy failures, to we learned that monetary policy cannot the business cycle. The adjustment process in the earìy ì980s was protracted and painful. This is not a lesson we should be counted on quickly i forget. smooth The ìesson of the ì980s js that monetary poìicy can controì nfìation and, i n doi ng so, can i nfì uence long-term real growth. ìnflation substantially. But it seems to me that markets still lack assurance that low inflation can be counted on in the future. He have reduced Consequentìy, it that the bulk of the gains from the diffjcult adjustments we made in the 1980s have not yet been real ized. l¡le are c ioser to may be argued 4them, certainly. But, for example, ìong-term interest rates are hÍgh, relative to recent inflation rates. Furthermore, managements sti I ì seem reluctant to embark on longer-term expansion plans, if those pìans entaiì significant longer-term commitments. I can onìy speculate, of course, but I beìieve that private decision makers need more assurance that inflation will not be allowed to accelerate beyond present rates and that to continue seek and achieve an infìation-free environment time frame. Providing that assurance might substantiaì we will indeed within a reasonabìe ly enhance ìong-term growth prospects. Lonq-term Reaì Growth and Profi ts This difficult increased the dividends adiustment credibility of in terms of to an environment of greater price stabillty monetary has policy and has begun to pay some ìong-term potential growth. I am optimistic about the outlook. A saìÍent feature of the current economic expansion has been the resurrection of productivity growth in U.S. manufacturing. Output per hour in manufacturing advanced .l982 average at a rapid 3.3 percent pace in ì987. Ihe 4.3 percent is the strongest five-year productivity boost jn the post-war period. Productivity gains, aìong with the doì lar's depreciation, since have heì ped restore Ameri can competi ti veness i n worì d markets. Thi s wi I I surely enhance real economic growth and profìts. of compensation growth in the manufacturing sector has complemented our gains in productivity. Indeed, unit labor costs ìn manufacturing fell last year for the fourth time'in the past five years -another post-war record. This, in turn, bodes well for our abiìity to achieve price stabiìity if we choose to do so. A surprisingly ìow rate 5in manufacturing are favorable, but The trends manufacturlng sector employs an increasingly force' smal we must not forget that the ler portÌon of the work shift of resources away from manufacturing towards the service sector seems likely to continue. The servìce sector, moreover, has not yet The exhibited much improvement a probìem of in productivity growth, although this may be par¡y measurement. Nevertheless, I for believing that the long-term prospects for growth are favorable. The structural changes in the ìabor force which dampened productivity growth in the .l970s have reversed. The proportìon of the work force in the oìder, more experienced age group is now rising. Labor force attitudes see grounds seem more consistent with the needs to jncrease product.ivity -- a development which may itself be the result of the ìess inflation-prone environment of the past fìve years. Management aìso seems to have developed new attitudes. The internationalization of product markets has increased competit.ion and forced management to intensify efforts to improve efficiency. As long as trade is free, these pressures will continue. Market discipììne is aìso evÍdent jn financial markets' Capital moves freeìy, and with it, as we have seen, comes new methods, technoìogies, and added pressures Deregulation, a growing appreciation and the most role of markets significant recognÍtion to improve effic.iency. of the need to are increasingìy important influences. perhaps economic trend under way here and abroad of the importance of markets and private improving innovation and is the government decisionmaking for productivity. In economies as different as the United Kingdom and Chìna there market alìocation improve eff.iciency, is a movement towards',privatization,,and of resources. In the United States this trend is called 6deregulation. Regardless of what it is cal led, strong private property rights are i mportant.' to. economi c effi c i ency. Thi s trend means pri vate sector controì over resource decisions and government less. Reducing government interference with private decisionmaking frees managers to managers have-more use resources i ìn accordance with the demands of the marketplace and encourages nnovation and producti vi ty. If we want to compete continue this trend in a global economy, it is important that we in the United States. 0ther countries are moving aggressively to strengthen private property rights and market forces within thei r own economi es. Conclusion At present, a number of deveìopments bode Infìation has subsided, the dol lar attitudes well for the ìong-term ouilook. has depreciated, productivi and demographic trends are favorable. My view ty has improved, is that the basic forces which drive ìong-term productivity and growth are stronger today than at any time in the post-war period. The Federaì Reserve can make a material contribution by stating clearly a long-term objective for monetary poì steadfastly pursuing that objective, the Federaì Reserve can provide environment that enables individual s and markets to maximize the potentiaì for make deci icy. an sions that long-term reaì economic growth and profits. By
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