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Risks in the Economic 0utlook:
A
Poì i cymaker'
l{. Lee Hoski ns, Presi dent
Federal Reserve Bank of Cleveland
ABA Funds Management Conference
San Diego, Caì ifornia
February
ì9, 1988
r
I
\
\
i
s Perspecti
ve
Like everyone else here,
js
focusing on the risk
I
read the newspapers, and today,s economìc
news
of a recession 'in .l988. Certainìy the stock market
crash ìast 0ctober and the weakening in consumer spending have
made most
forecasters more cautious.
Recession
is only
one
risk for the economy in l9gg. I
would
like to
of a couple of other risks which we shouìd not overlook. An
acceleration in prices is, of course, another. But perhaps the most
dangerous
risk is that an acceleration ìn prices this year wiìì become embodied in
remind you
ongoing infìation.
l4hile the focus on recession-inflation risks rarely extends more
than
to twelve months ahead, the focus required for policymakers to deal with
s.ix
the
long-term infìation
risk is years, not months. This rjsk is always present,
of course, but several characteristics of today's economy and the monetary
policy process itself cause me to be more concerned than usual.
Today, I would l ike to sketch out my v jew of the ouilook,
taìk about the
need for more explicit inflation objectives, and expìain
my concern with
current poì i cy di I emmas.
Few
of you need to be reminded that our current economic expansion,
its sixth year, ìs ìonger than all
now jn
but one other expansion since ì950.
Personal consumption spending s.lowed in r9g7, and we expect
continued
sìuggishness in personal consumption growth in 1988. It seems reasonabìe
expect
this
weakness
to
be
offset by strength in exports and investment.
to
-2Export growth
this year should be on a par with last year,s torrid pace, and I
expect business spending to remain strong this year. Today
a number of
jndustries are
stjll
at very hìgh levels of capacity. I do not see
a very compelling argument for forecasting a recession in the near
term.
However, these are good reasons to worry about an
acceleration in prices.
There was a substantial rise in prices of imported goods ìast year.
As
operating
Ímport prices continue to acceìerate, domestic producers have more
room to
raise their
prices, especiaìly ìn markets where capacity
is scarce.
Aìthough I expect business spending to be strong this year, it is
not yet
cìear how much of that spending wiìì be directed to capacity expansion.
Many
ohrn
business people are reluctant
to adopt bold expansion pìans, especiaììy
such pìans require a significant commitment to increase the number
of
employees. Another year
of solid profits
when
and economic growth, and clearer
that poìicymakers wilì not alìow an acceleration of infìation
needed before firms embark on major expansion plans.
evidence
may be
ly,
federal government spending i s aìways a question mark. Most
economists expect a reduction in government purchases this year
because of
Finaì
Gramm-Rudman
constraints.
However,
this is
an election year, and the
constraints have proven to be elusive even in non-eìection times.
on our productive capacity from all sources--consumers,
Gramm-Rudman
Demands
businesses, government, and foreigners--could strengthen again
next'
Capaci
ongoing
ty strai ns and hi gher import
pri ces could become embedded
i
n
inflation and jnflationary expectations.
Nhat safeguards do we have agaìnst
monetary
this year and
policy
inflation?
How
js, or wiìl be, too easy or too tight?
do we know whether
-3Economic policymakers must have
objectives and a framework which are
ìonger than the business cycle six months
to bring more discipline,
out.
and therefore more
to the poìicy process. In
my
Long-term object.ives are a
credibility
and more
way
certainty,
viely, an infìation-free environment should be
our primary objectìve because it
is the onìy way we have to achieve maximum
sustainabìe growth and other important goals. hle can make a materiaì
contributìon to reducing market uncertaìnty by specifying a path for reducìng
inflation, starting at about four percent for 1988 and going to zero jn some
reasonabì
e period--for
exampl
e, three to fi ve years
.
At one time, not long ago, onìy a few economists recognized the need for
stabìe price ìevel as the primary goaì for policy. But we have ìearned that
a
the central bank can controì onìy nomìnaì variables. He influence many reaì
ones, but ìargely through the environment provìded for private decisions. An
inflation-prone environment js not conducive to optimaì economic performance.
0f
poìicy
course, at any moment in time we don't reaìly know whether monetary
is too tight or too ìoose.
hle have never known
with certainty in
advance. From time to time we have been fortunate to have
that
/
worked
pretty weil,
such as the growth
some guideposts
of the money supply defined in
/^, o, another' During the past few years, the reiationship
money accordi ng
interest rates
to
previous ly-announced pì ans most I i kely
and asset
ìarge shìfts in the
prices to bear even
more
one
between money and
!úoul
d have forced
of the adjustment for
the
for money. The effects, if carrjed to an extreme,
probabìy would have produced needless shocks and fluctuations in real
variables and in financiaì markets.
demand
4In that regard, the public has been well served in the past few years by
the judgementally oriented poìicy of the Federaì Reserve. A test.imony to the
success
of the poìicy
can be seen
in the current ìong economÍc expansion
without accelerating
inflation.
risks which leave
uncomfortabìe. 0nly a decade or so ago, the Federal
Reserve
me
But the process contains some dangers
did not act quìckly or firmìy
and
to prevent inflation from gettìng
enough
out of controì.
Resi
stinq Pressures to Inflate
Achieving price
stability requires public
acceptance
of the idea that
price stabiìity is the only ìasting contribution toward economic growth that
the Federal Reserve can make. Ne cannot solve business cycìe problems just by
throwing money
of
government
Recent
at them. Thìs concept has been demonstrated in other
poìicy time and time
history suggests that
again.
monetary poìicy may help
to sustain
cycle expansions by resisting inflationary growth in economic
in this
spheres
business
activity.
Early
expansion, during 1984, the Federal Reserve tightened monetary policy
because the pace
of
economic
activity
was so
rapid that
it
threatened to
reignite inflation, Slowing the rate of money growth restricted the rate of
price increases. By not giving the public all the money it wanted, we helped
maintain discipìine on wages and prices. The expansion cont.inued,
i
and
nfl ation did not accelerate.
Last year we also tightened poìicy to
price leveì.
Money grew
be strengthening.
It
forestall
upward pressures on the
rapidly ear'ly in the year and the
was reasonable
to expect that
would be bidding prices up during the year, leadjng
economy appeared to
many market
particÍpants
to an acceìeration
jn
5infìation.
Today most anaìysts expect
been expecting
six
months
ago.
less inflation this year than they
The pace
of
had
economic expansion seems to have
in lìne
slowed somewhat, and perhaps our resource demands are now more
wjth
our abììity to supply at stabìe
prices. Keeping the rate of infìation
reìatively low, as we have done for five years now, has been a valuable
contribution to the longevity of this economic expansion. it seems to me that
our actions have added to the credibiìity of the commitment of the Federal
Reserve
to
keep
the infìation rate as ìow as possibìe.
The Current Di ì emma
My concerns
in
with the current situation
advance, a method
decj
for
inabiìity to specify,
from an
come
conducting monetary policy
that will guide policy
sions along a desired path toward longer-term objectives.
Today, markets see the Federal Reserve reacting
deciding from one
FOMC
meeting
to
news about
the
economy,
to the next where the greatest risks lie,
taking action accordìngly.
If
then markets expect the Fed
to ease. If the greatest risks
the greatest risks
seem
to lje in
seem
and
recession,
to lie
in
acceleratìng infìation, then markets expect the Fed to tighten.
This
is, of
course, not a new approach.
It
was used
for over
30 years
with good results in the 1950s and the earìy 1960s'--but the resuìts began to
deteriorate in the ìate 1960s and in the ì970s.
against recession, or the percejved threat
Pol icymakers,
ìn
hedging
of recession, lost sight of
long-term inflation goals and underwrote acceìerating inflation.
By reacting
to the economy in this
way
poìicy often
seems
driven
by
unpredictabìe events without clear l inks with longer-term objectives. Given
the bad experience
of the 1970s, the lack of a ìonger-term constraint
on
-6is itself
poìicy
and asset
a source of uncertainty and voìatiìe swings in lnterest rates
prlees, as you
know
alì
too weì1. The Fed may reduce uncertaìnty
about near-term interest rates--or the near-term economy, but
at the expense
of introducing more uncertainty about the long-term outcome. Nhat the Fed
does in the near term must be consistent with some known ìong-term objective
if policy is to be successful in minimizing risk and uncertainty in our
economy.
A credible zero
inflation poìicy
encourage ìnvestment and
economic growth by providing
with low interest rates.
environment
down
real
would achieve other goaìs as
The way
is to stabilize the price ìevel.
would be today
answer
is, I
furn i sh
that
and Japanese
if
we expected
doubt
that
ìt
Let
well.
Ne
a stable price
to get long-term interest rates
me ask you where
the long bond rate
zero-inflation in five years? Nhatever your
wouìd be
envi ronment provi di ng
8
112
percent.
there i s a
The Federal Reserve can
publ i c consensus. The German
central banks have done it, and there
is
no reason why we cannot.
Conclusion
It is possible that world growth will
seriousìy overestimated the future
forecasting a recession
errors in
my career
to
demand
in the year
know
slow
or that U.S. producers
for their products. I
ahead, but
I
am not
have made enough forecastìng
that a recession is possible.
It is also possibie
that inflation will accelerate into the fìve percent range by the
year, but
I
am
not forecasting that either.
have
end
of
the
-7 Beyond these
Some
risks, there is another, and I think it is
fear that the
Fed may
more enduring.
inadvertentìy make things worse by engineering
an
in inflation in an attempt to foresta'll a recession. This will
onìy bring added difficulties down the road for you in the financial markets
and for the economy as weìì. in doing so, we might ìose the opportunity to
acceìeration
achieve an
inflation-free
of the day, we have little
assurance that conditions will improve ìn the long run. If we focus only on
Unìess we
lift
environment and maximum sustainable economic growth.
our eyes from the probìems
short-run concerns, underlying probìems
continue to reemerge.
I
am
will
never be resolved and will
confident that you
not allow poìicymakers to forget those
in the financial
problems.
markets wiìl
:
@FedFRASER