Monetary Policy Report

Monet~ Policy Objectives for 1982 With tentative monetary growth ranges for 7983 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. With testimony presented by Paul A. Volcker, Chairman, Federal Reserve Board, July 20, 1982. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy in 1982 and 1983 1 The Growth of Money and Credit in 1982 1 Tentative Ranges for 1983 2 The Outlook for the Economy 3 Testimony of Paul A. Volcker, Chairman, Federal Reserve Board 5 Appendix-Alternative Seasonal Adjustment Procedures 13 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy in 1982 and 1983 There is a clear need today to promote higher levels ables. However, the Committee concluded, based on of production and employment in our economy. The current evidence, that growth this year around the objective of Federal Reserve policy is to create an top· of the ranges for the various aggregates would be environment conducive to sustained recovery in busi acceptable. ness activity while maintaining the financial disci The Committee also agreed that possible shifts in pline needed to restore reasonable price stability. the demand for liquidity might require more than or dinary elements of flexibility and judgment in assess The Growth of Money and Credit in 1982 ing appropriate needs for money in the months The annual targets for the monetary aggregates ahead. In the near term, measured growth of the ag reported to Congress in February were chosen to be gregates may be affected by the income tax reduc consistent with continued restraint on the growth of tions that occurred on July 1, cost-of-living increases money and credit in order to exert sustained down in social security benefits, and by the ongoing diffi ward pressure on inflation. At the same time, these culties of accurately accounting for seasonal move targets were expected to result in sufficient money ments in the money stock. But more fundamentally, growth to support an upturn in economic activity. it is unclear to what degree businesses and house At its July meeting, the Federal Open Market holds will continue to wish to hold unusually large Committee concluded that a change in the previously precautionary liquid balances. To the extent the announced targets was not warranted at this time. evidence suggests that relatively strong precautionary Because of the tendency for the demand for money to demands for money persist, growth of the aggregates run strong on average in the first half, and also res somewhat above· their targeted ranges would be ponding to a congressional budget resolution, careful tolerated for a time and still would be consistent with consideration was given to the question of whether the FOMC's general policy thrust. some raising of the targets was in order. However, the available evidence did not suggest that a large in crease in the ranges was justified; and a small change in the ranges would have represented a degree of "fine tuning" that appeared inconsistent with the degree of uncertainty currently surrounding the pre cise relationship of money to other economic vari- Ranges of Monetary Growth 19821 1982 Planned 1982 Actual 1982 Actual 1981 QIV'81-QIV'82 QIV'81-QII'82 QIV'81-June'82 QIV Levels* Mt 2 ½ to 5 ½ percent 6.B"percent 5.6 percent 436.7 M2 6 to 9 percent 9.7 percent 9.4 percent 1807.4 M3 6 ½ to 9 ½ percent 9.8 percent 9.7 percent 2171.3 Commercial Bank Credit2 6 to 9 percent 8.3 percent 8.0 percent 1323.1 • Billions of dollars, seasonally adjusted. I Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Tentative Ranges for 1983 The policy of firm restraint on monetary growth Looking ahead to 1983 and beyond, the FOMC re has contributed importantly to the recent progress mains committed to restraining money growth in toward reducing inflation. But when inflationary cost order to achieve sustained noninflationary economic trends remain entrenched, the process of slowing · expansion. At its July meeting, the l"OMC felt that monetary growth can entail economic and financial the ranges now in effect could remain as preliminary stresses. These strains-reflected in reduced profits, targets for 1983. Because the monetary aggregates in liquidity problems, and balance sheet pressures 1982 will likely be close to the upper ends of their place particular hardships on industries that depend ranges, or perhaps even somewhat above them, the heavily on credit markets such as construction, preliminary 1983 targets are fully consistent with a business equipment, and consumer durables. reduction in the actual growth of money in 1983. Unfortunately, these stresses cannot be easily In light of the· unusual uncertainty surrounding the remedied through faster money growth. Theim economic, financial, and budgetary outlook, the mediate effect might be lower interest rates, especial FOMC stressed the tentative nature of its 1983 ly in short-term markets. In time, however, such an targets. On the one hand, experience strongly sug attempt would founder, embedding inflation and ex gests that, with economic activity on an upw.ard pectations of inflation even more deeply into the na trend, precautionary motives for holding liquid tion's economic system. The present and prospective balances should begin to fade, contributing to a rapid pressures on financial markets urgently need to be· rise in the velocity of money. Moreover, regulatory eased not by relaxing discipline on money growth, .actions by the Depository Institutions Deregulation but by the adoption of policies that will ensure a Committee that increase the competitive appeal of lower and declining federal deficit. Moreover, a deposit instruments-as well as the more widespread return to financial health will require the adoption of use of innovative cash management techniques, such more prudent credit practices on the part of private as "sweep" accounts-also could reduce the demand borrowers and lenders alike. for money relative to income and interest rates. On· the other hand, the long upward trend in the velocity of money since the 1950s took place in an environ ment of rising inflation and higher nominal interest rates that provided incentives for economizing on money holdings; as these incentives recede, the at tractiveness of cash holdings may be enhanced and more money may be held relative to the level of business activity. Tentative Ranges of Monetary Growth 1983 Based on QIV'82 to QIV'83 Ml 2 ½ to 5 ½ percent M2 6 to 9 percent M3 6 ½ to 9 ½ percent Commercial Bank Credit 6 to 9 percent 2 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Outlook for the Economy The economy at midyear appears to have leveled off Change from end of previous Consumer Prices period, annual rate, percent . following sizable declines last fall and winter. Con sumption has strengthened, with retail sales up signif- IICPI D icantly in the second quarter. New and existing home CPI Excluding Food, Energy, and Homeownership 15 sales have continued to fluctuate at depressed levels, but housing starts nonetheless have edged upward. In the business sector, substantial progress has been made in working off excess inventories, and the rate of liquidation appears to have declined. On the nega tive side, however, plant and equipment spending, which typically lags an upturn in overall activity, is still depressed. The trend in export demand also con tinues to be a drag on the economy reflecting the dollar's strength and weak economic activity abroad. An evaluation of the balance of economic forces in dicates that an upturn in economic activity is highly likely in the second half of 1982. Monetary growth along the lines targeted by the FOMC should accom modate this expansion in real GNP, given the in pickup in production. The continuing rise in defense creases in velocity that typically occur early in a . spending and the associated private investment cyclical recovery, and absent an appreciable resur outlays needed for the production of defense equip gence of inflation. The 10 percent cut in income tax ment will be another element supporting real GNP rates that went into effect July 1 is boosting dispos growth. During its initial phase, the expansion is able personal income and should reinforce. the growth likely to be more heavily concentrated in consumer in consumer spending. Given the improved inventory spending than in past business cycles; current situation, any sizable increase in consumer spending pressures in financial markets and liquidity strains should, in turn, be reflected in new orders and a may inhibit the recovery in residential and business imrestment. The excellent price performance so far this year has been helped by slack demand and exceptionally Change from end of previous Real GNP period, annual rate, percent favorable energy and food supply developments. For that reason, the recorded rate of inflation may be 1972 Dollars higher in the second half of the year. However, pro spects appear excellent for continuing the downtrend 6 in the underlying rate of inflation. There has been significant progress in slowing the rise in labor com 3 pensation, and improvement in underlying cost pressures should continue over the balance of the year. Unit labor costs also are likely to be held down 0 by a cyclical rebound in productivity growth as out put recovers. Moreover, lower inflation will con tribute to smaller cost-of-living wage adjustments, which will moderate cost pressures further. HI H2 HI A critical factor influencing the composition and 1978 1980 1982 strength of the expansion in economic activity over the next year and a half will be the extent to which pressures in financial markets moderate. This, in 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis tum, depends importantly on the progress made in Federal Government Seasonally adjusted, further reducing inflationary pressures. A decrease in Borrowing annual rate, billions of dollars inflation would take pressure off financial markets in Combined Deficit Financed by the Public two ways. First, slower .inflation will lead to a reduc ed growth in transactions demands for money, given 120 any particular level of real activity. Second, further progress in curbing inflation will help lower long term interest rates by reducing the inflation premium 80 contained in nominal interest rates. Another crucial influence on financial markets and thus on the nature of the expansion in 1983 will be 40 the federal budgetary decisions that are made in coming months. The budget resolution that was 0 recently passed by the House and Senate is a con 1978 1980 1982 structive first step in reducing budget deficits as the economy recovers, but appropriation and revenue legislation is needed to implement this resolution. How the budget process unfolds will determine tary targets discussed above, these projections assume future credit demands by the Federal government that the federal budget will be put on a course that and thus the extent to which deficits will preempt the over time will result in significant reductions in the net savings generated by the private economy. A federal deficit. strong program of budget restraint would minimize Looking ahead, the Committee members, like the pressures in financial markets and thereby enhance Administration and the Congress, foresee continued the prospects for a more vigorous recovery in home economic expansion in 1983, but currently anticipate building, business fixed investment, and other credit a less rapid rate of price increase and somewhat dependent sectors. slower real growth than the assumptions underlying In assessing the economic outlook, the individual the budget. The monetary targets tentatively set for members of the FOMC have made projections for 1983-which will be reviewed early next year-would economic performance that generally fall within the imply, under the budgetary assumptions, relatively ranges in the table below. In addition to the mone- rapid growth in velocity. FOMC Members' Economic Projections Actual* Projected 1981 1982 1983 Changes, fourth Nominal GNP 9.6 5½ to 7½ 7 to 9½ quarter to fourth quarter, percent Real GNP 0.7 ½ to 1 ½. 2½ to 4 GNP Deflator 8.9 4¾ to 6 4 to 5¾ Average level Unemployment in the fourth Rate 8.3 9 to 9¾ 8½ to 9½ quarter, percent • Based on revised GNP data that were published after the full Humphrey-Hawkins report was submitted. 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Paul A. Volcker, Chairman, Federal Reserve Board I am p!,,,ased t,o ho.ve this opportunity in financial markets, in the practices of business and once again t,o discuss monetary pol;q financial institutions, and in labor negotiations-is a difficult and potentially painful process. Those, con with you within the context of recent and sciously or not, who had come to "bet'.' on rising prospecti,ve economic developmmts. As prices and the ready availability of relatively cheap credit to mask the risks of rising costs, poor produc usuol on these occasions, you have the tivity, aggressive lending, or over-extended financial ef positions have found themselves in a particularly dif Board Governors' ''Humphrey ficult position. Hawkins '' Report before you. This The pressures on fmancial markets and interest morning I want t,o enlarge upon some rates have been aggravated by concerns over pro spective huge volumes of Treasury fmancing, and by ef aspects that Report and amplify as the need of some businesses to borrow at a time of a severe squeeze on profits. Lags in the adjustment-of fully as I ton my thinking with respect nominal wages and other costs to the prospects for f,o the period oko,d. sharply reduced inflation are perhaps inevitable, but have the effect· of prolonging the pressure on pro fits-and indirectly on financial markets and employ ment. Remaining doubts and skepticism that public policy will "carry through" on the effort to restore stability also affect interest rates, perhaps most par Crossroads on Inflation ticularly in the longer-term markets. In assessing the current economic situation, I believe In fact, the evidence now seems to me strong that the comments I made five months ago remain rele the inflationary tide has turned in a fundamental vant. Without repeating that analysis in detail, I way. In stating that, I do not rely entirely on the ex would emphasize that we stand at an important ceptionally favorable consumer and producer price crossroads for the economy and economic policy. data thus far this year, when the recorded rates of In these past two years we have traveled a con price increase ( at annual rates) declined -to 3 ½ % and siderable way toward reversing the inflationary trend 2 ½ % , respectively. That apparent improvement was of the previous decade or more. I would recall to you magnified by some factors likely to prove temporary, that, by the late 1970s, that trend had shown every including, of course, the intensity of the recession; sign of feeding upon itself and tending to accelerate those price indices are likely to appear somewhat less to the point where it threatened to undermine the favorable in the second half of the year. What seems foundations of our economy. Dealing with inflation to me more important for the longer run is that the was accepted as a top national priority, and, as trend of underlying costs and nominal wages has events developed, that task fell almost entirely to .begun to move lower, and that trend should be sus monetary policy. tainable as the economy recovers upward momen In the best of circumstances, changing entrenched tum. While less easy to identify-labor productivity patterns of inflationary behavior and expectations- typically does poorly during periods of business decline-there are encouraging signs that both man agement and workers are giving more intense atten tion to the effort to improve productivity. That effort should "pay off'' in a period of business expansion, helping to hold down costs and encouraging a revival of profits, setting the stage fqr the sustained growth in real income we want. 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Economic Strains I am acutely aware that these gains against inflation I must also emphasize that the current problems of have been achieved in a context of serious recession. the American economy have strong parallels abroad. Millions of workers are unemployed, many busi Governments around the world have faced, in nesses are hardpressed to maintain profitability, and greater or lesser degree, both inflationary and fiscal business bankruptcies are at a postwar high. While it problems. As theyhave come to grips with those pro is true that some of the hardship can reasonably be blems, growth has been slow or non-existent, and the traced to mistakes in management or personal judg recessionary tendencies in various countries have fed ment, including presumptions that inflation·would back, one on another. · continue, large areas of the country and sectors of In sum, we are in a situation that obviously war the economy have been swept up in more generalized rants concern, but also has great opportunities. difficulty. Our financial system has great strength Those opportunities lie in major part in achieving and resiliency, but particular points of strain have .lasting progress-in pinning down and extending been evident. what has already been achieved-toward price Quite obviously, a successful program to deal with stability. In doing so, we will be laying the base for inflation, with productivity, and with the other sustaining recovery over many years ahead, and for economic and social problems we face cannot be built much lower interest rates, even as·the economy on a crumbling foundation of·continuing recession. grows. Conversely, to fail in that task now, when so As you know, there have been some indications much headway has been made, could only greatly most broadly reflected in the rough stability of the complicate the problems of the economy over time. I real GNP in the second quarter and s~all increases find it difficult to suggest when and how a credible in the leading indicators-that the downward ad · attack could be renewed on inflation should we justments may be drawing to a close. The tax reduc neglect completing the job now. Certainly the doubts tion effective July 1, higher social security payments, and skepticism about our capacity to deal with infla rising defense spending and orders, and the reduc tion-which now seem to be yielding-would be tions in inventory already achieved, all tend to sup amplified, with unfortunate consequences for finan port the generally held view among economists that cial markets and ultimately for the economy. some recovery is likely in the second half of the year. I am certain that many of the questions, concerns I am also conscious of the fact that the leveling off and dangers in your mind lie in the short run-and of the GNP has masked continuing weakness in im that those in good part revolve around the pressures portant sectors of the economy. In its early· stages, in financial markets. Can we look forward to lower the prospective recovery must be led largely by con interest rates to support the expansion in investment sumer spending. But to be sustained over time, and and housing as the recovery takes hold? Is there, in to support continuing growth in productivity and liv fact, enough liquidity in the economy to support ex ing standards, more investment will be necessary. At pansion-but not so much that inflation is reignited? present, as you know, business investment is moving Will, in fact, the economy follow the recovery path lower. House building has remained at depressed so widely forecast in coming months? levels; despite some small gains in starts during the These are the questions that we in the Federal spring, the cyclical strength "normal" in that in Reserve must deal with in setting monetary policy. dustry in the early stages of recovery is lacking. Ex As we approach these policy decisions, we are par ports have been adversely affected by the relative ticularly conscious of the fact that monetary policy, strength of the dollar in exchange markets. however important, is only one instrument of economic policy. Success in reaching our common objective of a strong and prosperous economy depends upon more than appropriate monetary policies, and I will touch this morning on what seem to me appropriately complementary policies in the public and private sectors. 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Review of Money Growth in 1982 Five months ago, in presenting our monetary and In conducting policy during this period, the Com credit targets for 1982, I noted some unusual factors mittee was sensitive to indications that the desire of could be at work tending to increase the desire of in individuals and others for liquidity was unusually dividuals and businesses to hold assets in the relative high, apparently reflecting concerns and uncertainties ly liquid forms encompassed in the various defini about the business and financial situation. One tions of money. Partly for that reason-and recogniz reflection of that may be found in unusually large ing that the conventional base for the M 1 target of declines in "velocity" over the period-that is, the the fourth quarter of 1981 was relatively low-I in ratio of measures of money to the gross national pro dicated that the Federal Open Market Committee duct. Ml velocity-particularly for periods as short contemplated growth toward the upper ends of the as three to six months-is historically volatile. A specificied ranges. Given the "bulge" early in the cyclical tendency to slow (relative to its upward year in Ml, the Committee also contemplated that trend) during recessions is common. But an actual that particular measure of money might for some decline for two consecutive quarters, as happened months remain above a "straight line" projection of late in 1981 and the first quarter of 1982, is rather the targeted range from the fourth quarter of 1981 to unusual. The magnitude· of the decline during the the fourth quarter of 1982. first quarter was larger than in any quarter of the en As events developed, M1 and M2 both remained tire postwar period. Moreover, declines in velocity of somewhat above straight line paths until very recent this magnitude and duration are often accompanied ly. M3 and bank credit have remained generally by (and are related to) reduced short-term interest within the indicated range, although dose to the up · rates. Those interest rate levels during the first half per ends. Taking the latest full month of June, Ml of 1982 were distinctly lower than during much of grew 5.6% from the base period and M2 9.4%, close 1980 and 1981, but they rose above the levels reach to the top of the ranges. To the second quarter as a ed in the closing months of last year. whole, the growth was higher, at 6.8 % and 9. 7 % , respectively. Looked at on a year-over-year basis, which appropriately tends to average through volatile monthly and quarterly figures, M1 during the first half of 1982 averaged about 4 ¾ % above the first half of 1981 (after accounting for NOW account shifts early last year). On the same basis, M2 and M3 grew by 9.7% and 10.5%, respectively, a rate of growth distinctly faster than the nominal GNP over the same interval. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Desire for Liquidity More direct evidence of the desire for liquidity or . their funds. A similar tendency to hold more savings precautionary balances affecting M 1 can be found in deposits has been observed in earlier recessions. the behavior of NOW accounts. As you know, NOW l would add that the financial and liquidity posi accounts are a relatively new instrument, and we tions of the household sector of the economy, as have no experience of behavior over the course of a measured by conventional liquid asset and debt full business cycle. We do know that NOW accounts ratios, has improved during the recession period. are essentially confined to individuals, their turnover Relative to incom~, debt repayment burdens have relative to demand accounts is relatively low, and, declined to the lowest level since 1976. Trends from the· standpoint of the owner, they have some of among business firms are clearly mixed. While many the characteristics of savings deposits, including a individual firms are under strong pressure, some rise similarly low interest rate but easy access on de in liquid asset· holdings for the corporate sector as a mand. We also know the great bulk of the increase whole appears to be developing. The gap between in in Mt during the early part of the year-almost 90% ternal cash flow (that is, retained earnings and depre of the rise from the fourth quarter of 1981 to these ciation allowances) and apending for plant, equip cond, quarter of 1982-was concentrated in NOW ac ment, and inventory has also been at an historically counts, even though only about a fifth of total Ml is low level, suggesting that a portion of recent business held in that form. In contrast to the steep downward· credit demands is designed to bolster liquidity. But, trend in low-interest savings accounts in recent years, for many years, business liquidity ratios have tended savings account holdings have stabilized or even in to decline, and balance sheet ratios have reflected creased in 1982, suggesting the importance of a high more dependence on short-term debt. In that perspec degree of liquidity to many individuals in allocating tive, any recent gains in liquidity· appear small. In the light of the evidence of the desire to hold more NOW accounts and other liquid balances for precautionary rather than transaction purposes dur ing the months of recession, strong efforts to reduce further the growth rate of the monetary aggregates appeared inappropriate. Such an effort would have required more pressure on bank reserve positions and presumably more pressures on the money mar kets and interest rates in the short run. At the same time, an unrestrained build-up of money and liquidi ty clearly would have been inconsistent with the effort to sustain progress against inflation, both because liquidity demands could shift quickly and because our policy intentions could easily have been misconstrued. Periods of velocity decline over a quarter or two. are typically followed by periods of relatively rapid increase. Those increases tend to be particularly large during cyclical recoveries. Indeed, velocity appears to have risen slightly during the se cond quarter, and the growth in NOW accounts has slowed. 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Monetary Targets-Balance of 1982 Judgments on these seemingly technical considera "valleys"-in monetary growth that seem likely to tions inevitably take on considerable importance in be temporary. As we have emphasized in the past, the target-setting process because the economic. and the data are subject to a good deal of statistical financial consequences (including the consequences "noise" in any circumstances, and at times when for interest rates) of a particular Ml or M2 increase demands for money and liquidity may be exception are dependent on the demand for money. Over ally volatile, more than usual caution is ·necessary in longer periods, a certain stability in velocity trends responding to "blips."* can be observed, but there is a noticeable cyclical We, of course, have a concrete instance at hand of pattern. Taking account of those normal· historical a relatively large (and widely anticipated) jump in relationships, the various targets established at the Ml in the first week of July-possibly influenced to beginning of the year were calculated to be consistent some degree by larger social security payments just with economic recovery in a context of declining in before a long weekend. Following as it did a succes flation. That remains our judgment today. Inflation sion of money supply declines, that increase brought has, in fact, receded more rapidly than anticipated at the most recent level for Ml barely above the June the start of the year potentially leaving more "room" average, and it is not of concern to us. for real growth. On that basis, the targets established It is in this context, and in view of recent declines early in the year still appeared broadly appropriate, in short-term market interest rates, that the Federal and the Federal Open Market Committee decided at Reserve yesterday reduced the basic discount rate its recent meeting not to change them at this time. from 12 to 11 ½ percent. However, the Committee also felt, in the light of developments during the first half, that growth around the top of those ranges would be fully accep *In that connection, a number of observers have noted that the table. Moreover-and I would emphasize this first month of a calendar quarter-most noticeably in January growth somewhat above the targeted ranges would be and April-sometimes shows an extraordinarily large increase in tolerated for a time in circumstances in which it ap Mt-amplified by the common practice of multiplying the actual peared that precautionary or liquidity motivations, change by 12 to show an annual rate. Those bulges, more typi during a period of economic uncertainty and tur cally than not, are partially ''washed out'' by slower than normal growth the following month. The standard seasonal adjustment bulence, were leading to stronger than anticipated techniques we use to smooth out monthly money supply varia demands for money. We will look to a variety of fac tions-indeed, any standard techniques-may, in fact, be incapa tors in reaching that judgment, including such tech ble of keeping up with rapidly changing patterns of financial nical factors as the behavior of different components behavior, as they affect seasonal patterns. A note attached to this in the money supply, the growth of credit, the behav statement sets forth some work in process developing new sea sonal adjustment techniques. ior of banking and financial markets, and more broadly, the behavior of velocity and interest rates. I believe it is timely for me to add that, in these circumstances, the Federal Reserve should not be ex pected to respond, and does not plan to respond, strongly to various "bulges" _;,or for that matter 9 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Monetary Targets-1983 The Blend of Monetary and Fiscal Policy In looking ahead to 1983, the Open Market Commit The Congress, in adopting a budget resolution con tee agreed that a decision at this time would-even templating cuts in expenditures and some new more obviously than usual-need to be reviewed at revenues, also called upon the Federal Reserve to the start of the year in the light of all the evidence as "reevaluate its monetary targets in order to assure to the behavior of velocity or money and liquidity de that they are fully. complementary to a new and more mand during the current year. Apart from the cycli restrained fiscal policy.'' I can report that members cal influences now at work, the possibility will need of the Committee welcomed the determination of the to be evaluated of a more lasting change in the trend Congress to achieve greater fiscal restraint, and I o{ velocity. want particularly to recognize the leadership of The persistent rise in velocity during the past members of the Budget Committees and others in twenty years has been accompanied by rising infla. . achieving that result. In most difficult circumstances, tion and interest rates-both factors that encourage progress is being made toward reducing the huge economization of cash balances. In addition, tech potential gap between receipts and expenditures. But nological change in banking-spurred in considerable I would be less than candid if I did not also report a part by the availability of computers-has made it strong sense that considerably more remains to be technically feasible to do more and more business on done to bring the deficit under control as the econ a proportionately smaller "cash" base. With incen omy expands. The fiscal situation as we appraise it, tives strong to minimize holdings of cash balances continues to carry the implicit threat of "crowding that bear no or low interest rates, and given the out'' business investment and housing as the econo technical feasibility to do so, turnover of demand my grows-a process that would involve interest deposits has reached an annual rate of more than rates substantially higher than would otherwise be 300, quadruple the rate ten years ago. Technological the case. For the more immediate future, we recog change is continuing, and changes in regulation and nized that the need remains to convert the intentions bank practices are likely to permit still more econo expressed in the Budget Resolution into concrete mization of M1-type balances. However, lower rates legislative action. of interest and inflation should moderate incentives In commenting on the budget, I would distinguish to exploit that technology fully. In those conditions, sharply between the ''cyclical'' and ''structural'' velocity growth could slow, or conceivably at some deficit-that is, the portion of the deficit reflecting an point stop. To conclude that the trend has in fact changed would clearly be premature, but it is a matter we will want to evaluate carefully as time passes. ·For now, the Committee felt that the existing targets should be tentatively retained for next year. Since we expect to be around the top end of the ranges this year, those tentative targets would of course be fully consistent with somewhat slower growth in the monetary ag gregates in 1983. Such a target would be appropriate on the assumption of a more or less normal cyclical rise in velocity. With inflation declining, the tentative targets would appear consistent with, and should support, continuing recovery at a moderate pace. 10 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Time to Move Ahead imbalance between receipts and expenditures even in In an ideal world, less exclusive reliance on monetary a satisfactorily growing economy with declining infla policy to deal with inflation would no doubt have tion. To the extent the deficit turns out to be larger eased the strains and high interest rates that plague than contemplated entirely because of a shortfall in the economy and financial markets today. To the ex economic growth, that "add on" would not be a tent the fiscal process can now be brought more fully source of so much concern. But the hard fact remains to bear on the problem, the better off we will be-the that, if the objectives of the Budget Resolution are more assurance we will have that interest rates will fully reached, the deficit would be about as large in decline and keep declining during the period of recov fiscal 1983 as this year even as the economy expands ery, and that we will be able to support the increases at a rate of 4 to 5 percent a year and inflation ( and in investment and housing essential to healthy, sus thus inflation generated revenues) remains higher tained recovery. Efforts in the private sector-to in than members of the Open Market Committee now crease productivity, to reduce costs, and to avoid in expect. flationary and job-threatening wage increases-are In considering the question posed by the Budget also vital, even though the connection between the Resolution, the Open Market Committee felt that actions of individual firms and workers and the per full success in the budgetary effort should itself be a formance of the economy may not always be self factor contributing to lower interest rates and reduc evident to the decision makers. We know progress is ed strains in financial markets. It would thus assist being made in these areas, and more progress will importantly in the common effort to reduce infla hasten full and strong expansion. tionary pressures in the context of a growing econ But we also know that we do not live in an ideal omy. By relieving concern about future financing world. There is strong resistance to changing pat volume and inflationary expectations, I believe as a terns of behavior and expectations ingrained over practical matter a credibly firmer budget posture years of inflation. The slower the progress on the might permit a degree of greater flexibility in the ac budget, the more industry and labor build in cost in tual short-term execution of monetary policy without creases in anticipation of inflation or Government arousing inflationary fears. Specifically, market anx acts to protect markets or impede competition, the iety that short-run increases in the Ms might presage more highly speculative financing is undertaken, the continuing monetization of the debt could be amelior greater the threat that available supplies of money ated. But any gains in these respects will of course be and credit will be exhausted in financing rising prices dependent on firmness in implementing the inten instead of new jobs and growth. Those in vulnerable tions set forth in the Resolution and on encouraging competitive positions are most likely to feel the confidence among borrowers and investors that the impact first and hardest, but unfortunately the dif effort will be sustained and reinforced in coming ficulties spread over the economic landscape. years. Taking account of all these considerations, the Committee did not feel that the budgetary effort, im portant as it is, would in itself appropriately justify still greater growth in the monetary aggregates over time than I have anticipated. Indeed, excessive monetary growth-and perceptions thereof-would undercut any benefits from the budgetary effort with respect to inflationary expectations. We believe fiscal restraint should be viewed more as an important complement to appropriately disciplined monetary policy than as a substitute. 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The hard fact remains that we cannot escape those discipline. It is precisely that environment that con dilemmas by a decision to give up the fight on infla tributed so much to the current difficulties. tion-by declaring the battle won before it is. Such In contrast, we are now seeing new attitudes of an approach would be transparently clear-not just cost containment and productivity growth-and to you and me-but to the investors, the business ultimately our industry will be in a more robust com men and the -workers who would, once again, find petitive position. Millions are benefitting from less their suspicions confirmed that they had better· rapid price increases-or actually lower prices-at prepare to live with inflation, and try to keep ahead their shopping centers and elsewhere; Consumer of it. The reactions in financial markets and other spending appears to be moving ahead, and inventory sectors of the economy would, in the end, aggravate reductions help set the stage for production increases. · our problems, not eliminate them. It would strike me Those are developments that should help recovery as the cruelest blow of all to the millions who have get firmly underway. The process of disinflation has felt the pain of recession directly to suggest, in effect, enough momentum to be sustained during the early it was all in vain. stages of recovery-and that success can breed fur I recognize· months of recession and high interest ther success as concerns about inflation re.cede. As rates have contributed to a sense of uncertainty. recovery starts, the cash flow of business should im Businesses have postponed investment plans. Finan prove. And, more confide:nce should encourage cial pressures have exposed lax practices and stretch greater willingness among investors to purchase ed balance sheet positions in some institutions longer debt maturities. Those factors should, in tum, financial as well as non-financial. The earnings posi work toward reducing interest rates, and sustaining tion of the thrift industry remains poor. them a,t lower levels, encouraging in tum the revival But none of those problems can be dealt with suc of investment and housing we want. cessfully by re-inflation or by a lack of individual I have indicated the Federal Reserve is sensitive to the special liquidity pressures that could develop dur ing the current period of uncertainty. Moreover, the basic solidity of our financial system is backstopped by a strong structure of governmental institutions precisely designed to cope with the secondary effects of isolated failures. The recent problems related largely to the speculative activities of a few highly leveraged firms can and will be contained, and over time, an appropriate sense of prudence in taking risks will serve us well. We have been through-we are in-a trying period. But too much has been accomplished not to move ahead and complete the job of laying the groundwork for a much stronger economy. As we look forward, not just to the next few months but to ·long years, the rewards will be great: in renewed stability, in growth, and in higher employment and standards of living. That vision will not be accom plished by monetary policy alone. But we mean to do our part. 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Appendix-Alternative Seasonal Adjustment Procedures For some time the Federal Reserve has been inves tend to moderate month-to-month changes tigating ways to improve its procedures for seasonal somewhat. adjustment, particularly as they apply to the monetary The Board will continue to publish seasonally ad aggregates. In June of last year, a group of promi justed estimates for M 1 on both current and alter nent outside experts, asked by the Board to examine native bases at least until the annual review of sea seasonal adjustment techniques, submitted their sonal factors in 1983. A detailed description of the recommendations. The committee suggested, among alternative method will be available shortly. 3 other things, that the Board's staff develop seasonal factor estimates from a model-based procedure as an alternative to the widely used X-11 technique that provides the basis for the current seasonal adjustment Growth Rates of M 1 Using Current6 and procedure ,4 and release the results. Alternative7 Seasonal Adjustment Procedures The Board staff has been developing a procedure using statistical models tailored to each individual 1981 1982 series. 5 The table on the last page compares monthly and quarterly average growth rates for the current Current Alternative Current Alternative Ml series with those of an alternative series from the Monthly Jan. 9.8 1.4 21.0 11.4 model-based approach. Average- Differences in seasonal adjustment techniques do Percent Feb. 4.3 7.5 -3.5 1.3 not change the trend in monetary growth, but, as Annual may be seen in the table, they do alter month-to Rates Mar. 14.3 16.0 2.7 6.4 month growth rates owing to differing estimates of the dhitribution over time of the seasonal component Apr. 25.2 22.6 11.0 4.5 in money behavior. Short-run money growth is vari May -11.4 -10.3 -2.4 0.5 able under both the alternative and current tech niques of seasonal adjustment, illustrating the in June -2.2 -0.6 -1.6 1.3 herently large "noise" component of the series. However, the redistribution of the seasonal compo July 2.8 2.2 nent under the alternative technique does on average Aug. 4.8 5.3 Sept. 0.3 3.1 Oct. 4.7 0.0 Nov. 9.7 11.1 Dec. 12.4 15.4 Quarterly QI 4.6 3.5 10.4 9.5 Average Percent QII 9.2 9.6 3.1 3.4 Annual Rates QIII 0.3 0.9 QIV 5.7 5.5 13 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Footnotes 1. M1 is the sum of currency held by the public, plus 5. The model-based seasonal adjustment procedures cur travelers' checks, plus demand deposits, plus other rently under review by the Board staff use methods based checkable deposits (i.e., negotiable order of withdrawal on the well-developed theory of statistical regression and (NOW), automatic transfer service (ATS) accounts, and time series modeling. These approaches allow development credit union share draft accounts.) of seasonal factors that are more sensitive than the current M2 is M 1 plus savings and small denomination time factors to·unique characteristics of each series, including, deposits, plus shares in money market mutual funds ( other for example, fixed and evolving seasonal patterns, trading than those restricted to institutional investors), plus over day effects, within-month seasonal variations, holiday ef- · night repurchase agreements and Eurodollars. fects, outlier adjustments, special events adjustments (such M3 is M2 plus large time deposits at all depository in as the 1980 credit controls experience), and serially cor stitutions, large denomination term repurchase related noise components. agreements, and shares in money market mutual funds 6. Current monthly seasonal factors are derived using an restricted to institutional investors. X-11/ARIMA-based procedure applied to monthly data. Bank credit is total loans and investments of commer 7. Alternative monthly seasonal factors are derived using a cial banks. model-based procedure applied to weekly data. 2. Because of the introduction of International Banking Facilities (IBFs), the bank credit data beginning in December 1981 are not comparable to earlier data. Thus, the target for 1982 was stated in terms of growth from the average level of December 1981 and January 1982 (shown in the last column) to the average level in the fourth quarter of 1982, so that the initial shift of assets to IBFs that occurred at the end of the year would not have a ma jor impact on the pattern of growth. Actual growth rates for bank credit are calculated from the December-January base. 3. See Committee of Experts on Seasonal Adjustment Techniques, Seasonal A<!justment of the Monetary Aggregates (Board of Governors of the Federal Reserve System, Oc tober 1981). 4. The current seasonal adjustment technique has most recently been summarized in the description to the mimeograph release of historical money stock data dated March 1982. Detailed descriptions of the X-11 program and variants can be obtained from technical paper no. 15 of the U.S. Department of Commerce (rev. February 1967) and from the report to the Board cited in footnote 1. A copy of the full report to Congress is available free of charge from Publications Services, Federal Reserve Board, Washington, D.C. 20551. 14 FBB 2-60000-0782 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1982, July 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19820720

@misc{wtfs_monetary_policy_report_19820720,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1982},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19820720},
  note = {Retrieved via When the Fed Speaks corpus}
}