Full text of Statements and Speeches of W. Lee Hoskins : Statement before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance, and Urban Affairs, U.S. House of Representatives

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:ùe:

'l¡[é,

For release on dellvery
l0:00 ô. [!. ¡ E. S . T,

February

6,

1990

Statement by

l{.

Lee Hosklns

Presldent, Federal Reserve Bank of Cleveland
before the
Subcomml

ttee on Domestlc l,lonetary pol I cy

of

the

Commlttee on Banklng, Flnance and Urban

.

U.

S.

House

of

Affalrs

Repres,entatl ves

February

6,

1990

4

Mr, Chalrman, I

am

pleased

on House Jolnt Resolutfon

to

appear before

409. I strongly

the Federal Reserr¡e Systen to

this

Subcommittee

to testlfy

supporc your resolution directing

prlce stability the maln goal of monecary
policy. UlElnately, the price level 1s determlned by monetary poliey. Ifhile
economic growth and

make

the level of

employment depend on

our resources and the

efflciency with which they are used, the aggregate price level is determlned
uniquely by the Federal Reserve. Efficient utllfzatlon of our natÍon,s
resources requlres a sound and predictable monetary

policy. H.J. Res. 4og

wisely directs the Federal Reserve co place prlce scability above other
economic goals because prlce stabilÍty is the nost important contribuÈion
Federal Reserve can make Eo achieve

full employlent

che

and maximu¡n sustainable

grolrÈh.

THE BENEFITS OF PRTCE STABILITY

Prlce Stabillry Leads ro Economic Stabiliry

An irnporEant

benefit of price stablliry is that it would scabilize

economy. Hlgh and variable

of financial crises
I.IWII

inflation has

always been one

and economlc recessf.ons.

the

of the prime causes

certainly u.s. experlence since

reaffirms the notlon that inflatlon 1s a leading cause of reeessions.

Every recession fn our recent history has been preceded by an outbursE

of

cosE

prlce pressures and the assoclated lnbalances and distortions. A monetary
policy that strfves for price stabillty, ot zeto Ínflation, as nandated by
and

H.J. Res. 409 would help markets avold distortlons and imbalances, stabilize
the business cycle, and promote the highest sustainable growth in our economy.

-2-

Price Stabilitv Maximizes Economic Efficlencv and Orrtorrt

A market economy achieves naximun productlon and grolrth by allowtng

Prices to allocate resources.

Money

markeÈ

helps make markets work more efficiently

by reducing infornaÈ1on and Èransactions costs, allowing for better decisions
and improved
make

productivlty in resource use. StabllízLng the price level

would

the monetary system operaEe nore efficiently and would result in a higher

standard

of living for all Americans.

Money

is a standard of value.

l,luch of

our wealth is held either in the form of money or in clairns denominated in
payable

in money.

Stabilizing
reduces

Ehe

Money represenEs

and

a clairn on a share of society's output.

price level proEects the value of that claim while inflarion

it.

Ilhen we borrow, we promlse

to

pay back the same amount

with interest.

we allow unpredictable

inflation,

to the borrower.

this conditlon persisEs, we create an environmenE in

Iltren

we

arbitrarily take from the lender

Ifhen

and give

which interest rates rÍse once to accommodate expected lnflaElon and again to
accomnodaÈe

the íncreased risk involved in dealing with an uncertain

inflation.

I.lhen

inflatlon rlses

and becomes

uncertain, people are forced to

develop elaborate, complicated, and expensive mechanisms

to proCect their

wealth and lncone, such as new accounting systems, markeÈs for trading

financial futures
trylng to

and optlons, and cash managers who spend

keep cash balances

at zero. It

would be

all their

inefficient

Eo

uime

allow the

length of a yardstick to vary over time, and iE is inefficient to allow

inflation co change the yardstlck for

economic value.

-3-

I'Ihtle the evidence that price stablllty maxlmlzes productfon

and

is not as direct or as extenslve as I would like, it ls persuasive
co me. One source of evldence cen be found ln the comparison of inflatlon and
employrnent

real growth across countrles. A nr¡¡nber of studies find that hlgher fnflation
or hÍgher uncertainty about lnflatlon is associated with lower real growth.
Inflatlon
Inflation

adds

risk to decisÍon-maklng

causes people

sole purpose of hedgÍng

end retards long-term investments.

to invest scarce resources ln activltles that have the
against inflaclon. Inflatfon interacts wlth the Ëax

structure to stifle lncentLves to invest.

More evfdence comes from

the excreme cases, the cases of hyperinflatfon.

There we see that economic performance

inflatlons.

Both

and people return

Even

clearly deteriorales wtch high

speclalizatlon and trade decllne as small ffrms go bankrupt

to

home

productíon for a larger share of goods and services.

a relatively predictable and noderate rate of inflatíon can be qulte

harmful. Durlng the

seven yeers

of our economic

expanslon sÍnce LgB2,

inflatÍon has averaged between 3 and 4 percent. I.Itrile that is low by the
standards of the 1970s, the purchasing power of the dollar has been reduced by
about 25

inflation

percent. Interest
and a prenlrrm

Research

raËes contLnue

to include a prenfu¡n for

expected

for uncertainty about inflatlon.

at the Federal

Reserve Bank

of Cleveland indicates that a fully

antfclPated inflatlon, with no uncertalncy about future lnflation, would
reduce the

capltal scock through taxes on capital incone. Uslng 1985 as a

benchmark and using conserrrecive assunpÈlons, we have esÈimated

that

the

-4-

inÈeractlon of an expected 4 percent lnflatlon rate with the tax on capital

to a Present value income loss in the American econony of
billion or more. This 1s an amount nuch greater Èhan Èhe output loss
income leads

(measured from

trend) durlng rhe 1980 co 1982 recession period.

$600

This

estimate 1s frorn a policy of a perfectly anticlpated 4 percent lnflation and

lncludes only the welfare loss assoclated with the failure to fully tndex
taxes on capltal lncorne. It lgnores the greater dâmage done to market

efficlency by maklng our nonetary yardstlck variable.l/
Even beyond these

costs, I belleve thet inflatlon diminishes productivity

gro$rth. Because the worldwlde slowdown 1n productivity grorrth occurred
simultaneously
Èhe evidence

with the acceleratlon ln lnflacion

and the o11

price shocks,

ls very dffficult to sort out satísfactorlly. But if I

am

correct in belfeving that inflatlon inhfbits productivity growth, the present
value of lost output from even a very small reducÈfon ln the Erend of

productivity growth would far exceed the

adJustrnent costs associated

with

the

transition to price stabilíty.

L/bttig, David

and Charles T. Carlstrom, "Expected

Inflatlon and che l.Ielfare

Losses from Taxes on Capital Income," Månuscrlpt, Federal Reserve Bank of

Cleveland, February 1990.

-5-

THE LTüITATIONS OF T.IONETARY POLTCY

A Fallaclous Trade-Off:

Inflatlon for Prosoerlty

Unfortunately, over the years we have cone to believe that we can prolong
expanslon,

or avoid recession, wich

remlnds us

that there is no trade-off

more

lnflation. A look at

between

fnflation

don't understand recesslons cornpletelY,

Alchough we

recenË history

and recession.

r{ê have seen

that they can

be caused by nonetary pollcy actlons as rvell as by nonmoneEary factors.

In the early
The

1980s we had recesslons caused by monetary

pollcy mistakes.

pollcy mlstake was the excessive monetary growth of the 1970s,

which

allowed acceleratlng lnflatlon and rising interesE rates and ultlmately led to

the need for dislnflatlonary monetary policles. The dfsinflationary policies
were necessery

activity.

to get our

economy back

YeÈ even todaY, wê

to an acceptable level of real

are apÈ to blame the recessions on policies that

lnflatlon instead of blaming the policies that created che inflation
to begin with. l,ltrlle recessions will occur even under an ldeal monetary

reduced

policy, they will not be as frequent or as severe. I,Ilth price stabllity,
would not have recessions lnduced by

inflatlon

we

and the subseguent need to

ellninaue lt.

Even

lf

ete thought thaE

elinlnatlng the business cycle

was

a desirable

and

healthy long-terrn goal, r belÍeve it is impossible to do so. There are
several reasons that prevent us from using monetary pollcy to offset
noru[oneËary

surprises. Flrst,

we cannot

predfct recessions. Second, monetary

pollcy does not work 1m'nediately or predictably; iÈ works with a lag, and the
lag is varlable and poorly understood.

-6-

The Crvstal Ball Svndrome

The 1lmiÈaÈions

of

economic forecasting are

well-known. Analysis of

forecast, errors has shown that r¡e ofÈen don't know that e recesslon has begun

untll ic fs well undenray. At
around economlc forecasts

any

point ln tl¡ne, the range of uncertaincy

of business activity for

is wÍde enough thau both expansion

one quarter 1n the future

and recession are plausfble outcomes.

The people who make forecasts and those who use them

sense

of confidence

because forecast errors are not

often get a false

dfstributed evenly over

the business cycle. l,lhen the economy is doing well, forecasts that prosperity

will continue are usually correct.

And when the economy

is performlng poorly,

forecasts that che slunp will contlnue are also usually correct. The problem

lfes

1n predlctfng the turning

thÍngs

r¡re musÈ

don't

However,

the Eurning points are

the

forecast, t,o prevent recessions.

Monetarv Pollcv's

l.Ie

points.

Lons and Variab'le Ì.aos

know exactly how a

particular pollcy actlon wlll affect

economy. Macroeconomlc ideas about monetary policy and

the

its effect on real

output have changed profoundly in the last decade as we have recognized that

the effect of monetary pollcy depends lnportanEly on how economlc agents form
and

alter expectatlons about pollcy.

-7-

Even

if

alleviate

we could predlcc recessions and wanted

thern, vte

stlll face an alnost

to vary

monetary

insurmountable problem

--

policy

to

monetary

policy oPerates wlth a lag. Moreover, the length of the lag varies over tlme,
depending on conditÍons

in the economy and on public percepcion of the policy

Process. The effect of coday's

felt for at least slx to nine

policy actlons will probably not

moneüary

be

months, wich Ehe main lnfluence perhaps trro to

three years ln che future. The act of trying to prevenc a recesslon may not

only fall, but nay also create a future recesslon -- via an fnflation --

where

ocherwlse there would not have been one.

Economic agenÈs, buslnessmen and consumers

The

political forces

alike, do not acE ln a vacuum.

operaÈing on a central bank make

possibility. Uncertainty about future inflation

adds

inflatlon always a
risk to future

lnvestments. Uncertainty about future inflacion will raise real interest

rates, drive lnvestors
adjustments needed

to

away from long-term

end the

recession.

the stabilicy of future monetary pollcy,

narkets, and delay che very

The more

Èhe more

certain people are about

easlly and quickly lnflation

can be reduced and the econotry can recover.

Lessons I.Ie Should Have Learned

If

we have learned anything abouc economic policymaking

years, we ought to have learned to thlnk
To

abouc

clain Èhat "ln order to reduce lnflatlon,

wrongheaded

we

20

policy as a dynamic process.
nust have a recession,tt is

notion thaÈ courpleÈeIy ignores the abtlity of

Èhelr expectations as Èhe environment changes.

Ín the last

hu¡nans

to

adapt

a

-8-

People do Èheir besÈ

to forecasc

decislons. If the central

economic

bank has a record

pollcles

of

when they make

expandlng the money supply in

attenPts to Prevent, recesslons, people w111 come Co anticipate the poliey,

setting off an acceleraÈlon of lnflation
w111 lead

of resources thaÈ

to a recesslon.

An econony often goes

lnflatlon

and mlsallocatlon

lnto recession following

an unexpected

burst of

because people have made decfslons thaÈ Ì{ere based on an incorrect

view of the future course of assec prices and economfc actlvity.
bank can help prevent the need

for

The central

such adjustments by provlding a stable

price environment. Moreover, price stability will be the optlmal seÈting for
adjustments

in business invenÈories

and bad

debts, should such

adJustmenÈs be

necessary.

THE II.IPORTA}TCE OF ADOPTINC HOUSE JOINT RESOLUTION 409

Sound

Policfes Mlnimize Uncertalntv

Econonic

policies must have clear obJectives, veriflable

ouÈcomes, and

rules that are consistently adhered to ln order to nlninize uncertainty.
Predictable, verÍfiable policles ensure that long-tern plannÍng and resource

allocation decfslons

w111 be

efficienÈ.

Sound

policy thus requlres a resolute

focus on the long Èern and resistance to pollcies Èhat, while expedient 1n the

short run, lntroduce more uncercainty lnto an already unpredictable world. If
enacted, H. J. Res. 409 would make a valuable contrlbutlon to thls lmportanE
obJ

ective.

-9-

In the long run, lnflation is the one economic variable for which monetary
pollcy is unanblguously responslble. The zero tnflatlon pollcy called for in
H.J. Res. 409 satisfles the key requÍrements of sound pollcy: it ls c1ear, ic
ls verifiable, and 1t has consistent rules. Unllke other rates of lnflation,
zero lnflatlon is a policy goal chat !¡i1l be understood by everyone.

Resoondinø to Multiola

Goa'l

.c

The Federal Reserve Reform AcÈ

of

1977 amended

chat it now requÍres Ëhe Federal Reserve ".

of

maxlmr¡¡n employment,

However,

.

.

to

the Federal Reserve Act

so

promote effecÈlvely the goals

stable prices, and moderate long-term lnterest rates.,,

it is the Federal Reserve's responsibilicy to decide

how

best

Èo

pursue those goals.

Because

of the multlpllcity of goals establlshed by Congress for

Federal Reserve, Ehe Federal Reserve can choose which goal
any mornent. Such discretion increases the

ít

che

emphaslzes at

likelihood that polltical

and

special-lnterest groups could try to fnfluence the Federal Reserve to

pursue

the pollcy that ls currenÈly lmportant to that group.

In this respect, the Federal Reserve's sltuatlon 1s different from that of
lüest Gernany's central bank, which

is also lndependenÈ.

More than one goal is

speclfled by law for that bank, buÈ German law stetes that the goal of prlce

scabillty ls to be given highest prtorlty
with maintainfng price stablllty.

whenever anocher goal nlghÈ

confltcr

Thls ls a maJor reason why l.Iest Germany,s

price level only doubled between 1950 and 1988, whlle the U.S. price level
quadrupled.

-10-

Slnce current law requires the Federal Reserr¡e

to

promote

emplolment, stable prlces, and moderate long-term fnterest
Reser¡e musË choose a

maxlmu.m

rates, the Federal

vlable strategy to acconplLsh thls rnfssion.

Two

approaches seen plauslble.

One approach would be
among

for the central bank to try to achleve a balance

its three Congressionally

mandaÈed

obJectlves. The Federal Reserve could

use lts own judgnent about what balance among the obJectlves to pursue, and
could change that balance from time to tlme, dependfng on .lcs viçw of how the
economy works and what

essence,

course ls broadly acceptable to the publ1c. rn

thls is the pracEice that the Federal

strlved to balance deslrable

economlc condltlons such as

econo¡nic growth, and low long-term

Buc the maJor drawback

to thls

approach

sÍmulËaneously

monecary

followed. It

full

has

emplo¡rnent,

lnterest rates with low rates of inflation.

fs its feasibillty.

balance anong the nandated goals requfres

another. Furthermore,

Reserve has

To

strlke

a

that they be reliably linked to

one

pollcy would need co be capable of tnfluencing

all these economic dlnensions in the desired dlrections and

quantities.

Ilhile
to

nonecary

1nÈermedlate

polfcy 1s capable of influenclng

Èhe economy

ln the short

run, over long periods of tlne monetary pollcy can only affect

the rate of lnflation.

The

rate of inflation, in Èurn, affects all

dlmensfons

of econonic performance, lncluding outpuc, employnent, and lnÈerest rates.
Maxlmr.¡^n

producÈlon and enployment and low inÈerest rates can be achleved only

wlth price stablllty.

-

11-

By lts very nature, a balanclng act among conplex economic goals causes

substantlal confusion about the Federal Reserve's l-ntentlons. Such confusion
could be avoided to a large degree if Congress or the Federal Reserve assigned

priorlties

to the goals.

A more promisÍng approach

is to select

one obJective

-- the only

one that

the Federal Reserve can influence dfrectly. Under the provislons of H.J.

Res.

409, the Federal Reserrre would seek to nalntain a stable price level over

time. Price stabillty Ís defined as an inflatlon rate so small that it does
not systematically affect econonic declsions. The definltlon may appear less
specffÍc than
agents

llke, but I believe thaÈ

wlll be very important ln monitorfng

stabllity.
found

some v¡ould

In.practice,

Ëhe sLze

success

of the inflation

fn long-term interest rates,

sur¡/eys

of

che

expectatLons, and other market-generaEed measures
can be very

Ehe

declsions of

economic

ln achieving price

premfum

estinated ro

be

publlc's inflaEion
of inflatlon expectations

useful. If pollcy is credfble, both the inflatlon

component and

the Ínflatlon uncertalnty risk premiu¡¡ would be ellmlnated from interest

rates.

Ternporary and unforeseen

frorn che deslred

factors w1ll cause the prlce level Eo deviaEe

course. It would be a mistake to try to keep sone inflatlon

index on target each and every quarter, or even each and every year.

Prlce stabllity can be achleved by holdlng the

money

supply (as

measured

by M'2) on or close to a peth which is conslstenÈ wich price stability over

long perlods. The relationshlp between money and the prlce level over long
perlods of tine is stable and strong. However, the link between money and the
economy over

perlods perhaps as shorÈ as a year is loose enough to afford

Federal Resen¡e conslderable leeway 1n responding

to

problerns and

che

crises - -

as

-L2-

long as economlc agents belleve thaÈ Ëhe future value of

Clearly, this resolutlon

would

money

wtll be stable.

not prevent the Federal Reserve from providing

llquidtcy in times of financlal crises,

such as the stock market crash in

1987.

AnnouncinE a Cornml-tment to Price Stabilitv

Announcement

of a cornmltmenc to prlce stablltty, as embodied ln H.J.

Res.

409, would enhance che abilicy of Congress to hold the Federal Reserve
accountable

for achlevlng the goal. Central-bank accountabiltty is

appropriace ln a democracy and, in fact, Congress has the ultlmaÈe auchority

to

change

the Federal Reserve's goal.

A legislative conrnftmenE to price stabillty would also enhance the Federal
Reser:¡e's lndependence from
corn¡nitment

policical pressures as ic pursued that goal.

by Congress co prlce stabflity would reduce the effectiveness of

policlcal pressure to deviate fron that goal. Thus, a distincEion
beLween

A

can be

made

a central bank thac Ís accountable for long-run performance and a

central bank that can be influenced

Èo pursue

short-run goals that might

be

incompatible wiuh desirable long-term economic performance.

The commitment

to price stabllity

supported by a

leglslatlve

mandaÈe would

foster the credlblllty of the Federal Reser¡¡e. Improving the Federal
Reserve's

stable,

credtbility would strengthen the

and would conÈribute Eo

stab11lÈy easier

to achleve

price

expecEaEion thaÈ

and wage declslons

and malntain.

prices will

be

that would make pri""

-13-

ARGI'}ÍENTS ACAINST ADOPTINC HOUSE JOINT RESOLUTION

Wtrat AbouÈ

409 ARE

WEA¡(

the Transltíon Costs?

A connltmenÈ by Congress and the Federal Reserve

stablllty would entail

adjustxnent

costs.

to achieve price

AdJustment costs would

two sources: contracÈual obligaÈfons and the

arise

from

crediblllty problem, or

uncertainty about whether prlce stability would be achleved and malntained.
The contractual costs can be allevlaEed

wlth an approprlate adjustment perlod.

H. J. Res. 409 recognizes that abrupt policy changes can be dlsruptlve

and

provides a phase-in perlod to help reduce adJustnent costs.

Much

of our day-to-day econonic activiEy ls

commltments

exPectations

that

exEend

conducted under contracts and

over longer perlods of tlne and chat

of a continuing uroderate lnflation rate.

will expire ln the next few years.

The

Most

ernbody the

of these contracEs

disruptlon to buslness and the

arbitrary wealth redistributlon of an abrupt adJustnent to prlce stability
would be

greatly reduced by an appropriate phase-ln period. H. J. Res.

gives us five years to get to prlce stabtllty
reduce substantlally the

The second
economlc

set of

- a perlod long enough to

transltlon costs.

adJustmenÈ

costs enenates from Èhe expectations of

agents. As the Congresslonal Budget Office points out ln lcs recent

Economic and Budeet Outlook,

reduced

-

409

to zero,

lf

everyone belleved

that inflation

and planned accordlngly, these costs would be

Federal Resen¡e has stated

would be

very Iow.

The

that it intends to reduce lnflation to zero or to

low levels, but 1t has noÈ comlnitced co

a

speclflc tlmetable for ellnlnating

-L4-

lnflaulon, or co a plan for dolng so.

The resulc

is chat the public in

general and Èhe markets ln partlcular wonder Just how serlous

lntentlons, or whether
have

we

wfll switch our prlorities

rÀre

are ln those

Eo some oÈher

goal, as r¡re

ln the past.
of the Transltion cost

Large-scale Econometric Model Estlmates

Econonists have not made nuch progress

of eliminatlng inflatlon.
number

of

fn estlmating the transltion

FrequenEly, econometric models

complex relationships and varÍables are used

adJustrnent

costs. For nanageabillty,

that

embody

to estimate

econometrlc nodels are

costs

a large

the

bullt with

many

simpltfying assumPtfons, one of r¡hich ls che presr.unptlon chac economlc agents
are bacla¡ard-looklng ln the way they form and change expeccations. In these
models, exPectations, whlch

in effect determine adjustnenc costs, are formed

from past experlence, and are changed only slowly as the future

unfolds.

The

presumption Ehat expectations change only slowly ineviEably generates

estlmates of high transltion costs. Ihe real questlon about a change in

pollcy as speclfled by H. J. Res. 409 !s
would behave under a
models are

fully credible

and

how forward-looking economic agents

fully

understood

policy change.

Such

relaÈlvely useless fn answering this question.

In alnost every cese,

such models are constructed

to display the effects

that are conslstent wfth the nodel builder's theorles and biases. Alnost all
of the large nodels are based on the dual notfon that the only vray Eo
ell¡ninate lnflation is Eo ralse the unemployment rate. Naturally, these
nodels w111 flnd

that ellninating lnflation ls very costly.

have been conducted ¡nany Eines

ln the past,

These exercises

and they have conslstently

-15-

overestlnated.che costs of elimlnating lnflatlon and lgnored Èhe beneffts of
doing so. I nlght also observe that those who really believe the analytlcal

structures contained ln these models logically should advocate an acceleration

of fnflatlon

because the models would

One member

has

of the Council of

predlct great beneflts from doing

Economlc

developed large econometrlc models

lnduced by labor

contracts.

Even

Advisors, an experÈ on such macters,

with sluggish resource

adJustmenÈ

ln these models, there is almost

no

short-run cost Eo eliminating inflatlon with a credible policy change.
reason

so.

is sinply that, 1n these models, people are

assumed

to

The

their

change

behavior in response !o the policy change,

As the

CBO

study states, "inflatlon could be reduced relatlvely palnlessly

by lowering lnflatlonary expecÈaclons. " A commlÈnenc by the Congress and the
Federal Reserr¡e would enhance

credibility

and convince economic agents

co

begin to base declslons on gradual elininaÈion of lnflation over a five-year

period.

The

transltlonal costs presented elsewhere in the CBO study

then

would be grossly overestinated.

A consistent conniLment to a long-run pollcy goal of price stability is

ÍmPortanc. One of the vrorst chlngs we could do fs to elimlnate lnflation for
a whlle and then return to high inflation later.

H.J. Res, 409 would

contribute to an fmportant, change 1n the policy process, focusing tt toward
conslstenÈ long-run goals and away from reactlons t,o each new report of
economic

Èhat

activity.

Each

pollcy action would

becone

is consistent wlrh long-run prlce stabiliry.

part of a pollcy

process

-16-

Ffscal Polfcy Is No Obstacle ro Prlce Scablllty

Federal budget

deficits should not

cotrpromise

eicher the Federal Reserr¡e's

goal of price stability or the adoptlon of a speclflc tfnetable to achieve it.

I

do not mean to suggesE

or imply that current fiscal políey ls ideal,

appropriate, or the resulc of bad monetary pollcy. Savings are Èoo low, at

least parÈly

because

of budget deficÍts,

shortfall nust lnclude

measures

and neasures

to reduce the deficlt.

strive for betEer fiscal policy,

we should recognlze

cannot offsec whaÈever harrn may resulc from
add

to address our
However,

that

savings

whlle

moneEary

we

pollcy

flscal policy; lndeed, lc can only

to those costs.

I^Ie

cause

keep

are all fanlllar wlth the argr:ment that large federal budget deficlÈs

high lnteresE rates, forcing the Fed to ease monetary policy fn order to

lnterest rates at levels consistent with full enplo)ruent. Thls

argument

ignores the fact chat boch the federal budget deficit and, more lmportant,
goverrunent spending,

at least

neasured

falllng for the past several years
There 1s,

relatlve to

che econony, have been

and should contlnue

to do so.

of course, legftfnate concern chat the progress fn deflcit

and

expendlture reductfon might cease or even be reversed, for any number of

reasons.

How

should such a reversal lnfluence monecary pollcy? Even if

fiscal pollcy choices were to
is lictle

puÈ upward pressure on

consensus among econonisÈs thac

lnterest rates,

thls ls the case, lt is far

and Èhere
from

clear that the Federal Reserve can do anythlng co allevlate the economic
consequences

affect the

of that problen. Ultlnately, ic ls real interest rates Èhat

consrrnptlon and productlon decisions

of lndividuals

and businesses

-L7 -

allocatlon of resources over Eime. Real rates of return are based on

and the

the producÈlvlty of labor, capftal, and other real assets in a soclety,
have very

llttle,

if any, connection with

monetary policy.

In an lnflationary envirorìment, nomlnal rates of return include
inflation

prenium Co compensaEe lenders

and

for being repaid ln

money

an

of

reduced

Poiter. The correlatlon beEween monetary pollcy and nomfnal
interesÈ rates that domineÈes dlscusslon ln the flnanclal press cells us nexE

purchaslng

to nothing about the relationshlp

becween moneÈary

pollcy and the real

interest rates that govern che allocation of resources over tlme.
movement

fn

Che

Every

federal funds raÈe does not produce equlvalent changes ln real

inËerest rates, in the productivity of our capltal stock, or ln any of the

other lmportant real variables that affect economic acEivlty. The fact that
monetary
does

pollcy exerts relatively direcÈ control over the federal funds rate

not imply that real interest rates can, sinilarly, be controlled

by

monetary policy.

It ls

unnecessary and undesirable

for

sound monetary

policy cholces to

awalt sound fiscal pollcy choices. Sound fiscal poltcy decisions, like

private

econornlc

Res. 409 would

declslons, require

dlrect the Federal

Ehe sÈable

Reserve

inflatlon

to provide.

environnenÈ

sound

that H.J.

The tax-related

dlstortlons and economlc conplexltfes associated wlch even stable, posiEive
rates of lnflatfon argue strongly for price stabllity.

-18-

CONCLUSION

If H. J. Res. 409 ls

enacted and the Federal Reserr¡e comnlts co an

explfclt plan for prlce stablllty, the transitlon perlod w111 soon be
and any costs

that erise

because

of this policy

change

over,

wtll be outweighed

by

the benefits. These beneflts w111 be large and pernanenc, and wlll far
outwelgh the coscs
mllesÈone
monetary

of gettlng there. H. J. Res. 409, lf enacted, would be a

fn econonlc pollcy legislatlon

pollcy

away from short-Eerm

because

lt would shlfÈ the focus of

fine-tunlng to the long term, where it

belongs. It would enforce accounÈabilicy for the one vital obJective Èhat
Federal Reserve can

achleve. It would officially sanction those sometimes

unpopular short-run pollcy actions that most certainly are
long-Èerm

lnterest. It

would make clear

that the Federal

achfeve maxfmr¡n output and employment wlthout achleving

fully support House Jolnt Resolutlon

409.

in our natÍon's

Reserve cennot

price stablllty.

I

the