Monetary Policy Report

tl~du~ ----•:•.-----·' ----- .1J?-f •...• •. I,,,' i',1 . , Policy Monetary Objectives for 1983 ·?)&Wt. <f)...dA Midyear Review of the Federal Reserve Board July 20, 1983 f 1d1r1I l111rw1 Bank If Phllallel,hla LIBRARY Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy Objectives for 1983 With Tentative Monetary Growth Ranges for 1984 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, 1983. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy in 1983 and 1984 2 Growth in Money and Credit 2 Monitoring M 1 and Debt 2 The Outlook for the Economy 3 Testimony of Paul A. Volcker, Chairman, Federal Reserve Board 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy in 1983 and 1984 Growth in Money and Credit M3 Billions of dollars During July, the Federal Reserve reviewed its 1983 target ranges for money and credit and established --- Range adopted by FOMC for 1982 Q4 to 1983 Q4 tentative ranges for 1984 in light of its basic objec tives of encouraging sustained economic recovery 2600 while continuing to make progress toward price stability. In setting these ranges, the Federal Open Market Committee recognized that the relationships 6~'Jli ........ 2500 among the money and credit aggregates and ........ ........ ........ economic activity in the period ahead are subject to ........ considerable uncertainty. Consequently, it was em phasized that, in implementing policy, the 2400 significance to be attached to movements in the various measures of money would depend on evidence about the strength of economic recovery, the outlook for prices and inflationary expectations, ONDJ FMAMJ J ASOND and emerging conditions in domestic and interna 1982 1983 tional financial markets. The Committee reaffirmed the 1983 ranges for the broader monetary aggregates-M2 and M3. The tentative ranges for next year set for these aggre In setting these tentative ranges, it was expected gates were reduced by ½ percentage point. that shifts into money market deposit accounts (MMDAs) would not significantly distort growth in the broader aggregates, in contrast to the experience in the early part of this year. M2 Billions of dollars With greater growth in real (and nominal) GNP ---Range adopted by FOMC for than anticipated earlier-but in the context of Feb./Mar.-1983-to Q4 1983 moderating inflation-actual growth in M2 and M3 .lO'Jli2200 .,,. may reasonably be higher in the ranges than .,,..,,. 7'Jli thought likely earlier . .,,..,,. .,.., 2150 Th~ FOMC also agreed that principal weight would continue to be placed on the broader 2100 monetary aggregates in the-implementation of monetary policy, in view of the continuing uncer 2050 tainties that attach to the behavior and trend of M1 over time. 2000 Monitoring Ml and Debt 1950 Recent evidence suggests that the declines in the 0 N D J F M A M J. J A S O N D velocity of Ml may be abating. The income velocity 1982 1983 of M 1 declined only modestly in the second quarter of this year. The upward impact on M1 demand of earlier interest rate declines has faded and, given the sizable buildup in liquid balances that has taken place, it seems probable that some pick-up in the 2 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis velocity of M 1 will develop over the quarters ahead, M 1 growth would be expected to move lower in in closer conformance with cyclical and secular pat these ranges as and if velocity strengthens. terns of earlier years. Whether any rise in velocity The Committee reaffirmed the previously an would be as strong as in earlier decades of the post nounced range for monitoring domestic financial World War II period remains uncertain. debt in 1983, and reduced the range by ½ percen Taking account of the various uncertainties, for tage point for 1984. the purpose of monitoring Ml behavior, the Com mittee established the growth range shown below The Outlook for the Economy ( annual rate) for the period from the second quarter to the fourth quarter of this year. The decision to When the year began, an economic expansion was establish a new base (the second quarter) for underway, but it was widely expected that the monitoring M 1 reflected a judgment that the rapid recovery, at least in its initial phases, would be growth over the past several quarters should be significantly less rapid than the average postwar treated as a one-time phenomenon, neither to be cyclical upswing. retraced or long extended. The monitoring range for By the second quarter, however, the recovery had Ml tentatively established for the period from the gained vigor and was following in most respects a fourth quarter of 1983 to the fourth quarter of 1984 typical cyclical pattern. Advances in residential con is also shown below. These ranges anticipate no fur struction were exceptionally large during the first ther decline in the velocity of M 1 during a period of half, and there were sustained increases in consumer relatively strong growth in economic activity and spending, particularly for durable goods. Businesses allow for the likelihood of some rebound in velocity. continued to liquidate inventories at a rapid· pace through the first quarter, but then apparently began rebuilding stocks in the second quarter as final demands strengthened. Employment gains became Ranges of Broader Aggregates, 1983 and 19841 1983 Range 1983 Actual2 1984 Tentative2 Base Levels2 Billions of Dollars Percent Percent Percent Seasonally Adjusted M2 7-10 9.1 6½-9½ 2060.4 M3 6½-9½ 9.6 6-9 2366.6 Monitoring Ranges for Mt and Debt, 1983 and 19841 1983 1st Half 1983 2nd Half 1983 Actua12 1984: Tentative2 Base Levds2 Billions of Dollars Percent Percent Percent Percent Seasonally Adjusted Ml 4-8 5-93 13.9 4-8 473.6 Total Domestic Nonfinancial Debt 8½-11 ½ No Change 10.6 8-11 4750.0 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Change from end of previous Real GNP period, annual rate, percent reached in the second quarter, and with mortgage interest rates no longer falling, outlays for residential 1972 Dollars construction seem unlikely to continue rising at the extraordinary pace of early 1983. The foreign sector, 8 too, will be exerting a restraining influence on growth of output in the United States, owing to a strong dollar, relatively slow growth in the other in dustrial nations, and financial difficulties besetting many developing countries. Employment is likely to continue expanding as the recovery in output progresses, with gradual declines in the unemployment rate. However, if past ex perience is any guide, the strengthening economy 1977 1979 1981 1983 will itself prompt more job-seekers to enter the labor •Data for 1983-Hl arc based partly on advance projections from the Commerce force, thereby reinforcing the inertia of the Department. . - unemployment rate. Consequently, unemployment will remain high, relative to the earlier postwar period, for some time. substantial as the recovery gathered speed, and the unemployment rate in June-while still high Inflation Outlook historically-was three-quarters of a percent below The near-term outlook for inflation continues to be the earlier peak. reasonably favorable. Wage pressures have Given the momentum of the recovery-and the moderated further into 1983, productivity is improv- added stimulus of another reduction in personal truces at midyear-there is a strong likelihood that real GNP will continue growing at a healthy pace through the second half of 1983. Gains in employ ment and output have generated sizable increases in Change from end of Consumer Prices income, which in tum are laying the groundwork previous period, percent for further advances in consumer spending. And, 1972 Dollars business spending on equipment appears to be turn ing up. The cumulative forces of economic expan 15 sion thus appear to be well established. • Real GNP growth in the second half as a whole may not match the rapid second-quarter pace, which 10 partly reflected the sharp swing in inventory posi tions. In addition, given the level of housing starts 5 1977 1979 19!U 1983 •Price changes for 1983-Hl arc based on data li>r the December to May period. 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ing, and the continued strength of the dollar is Recently, the concerns on that score have been limiting increases in the prices of imported goods. heightened somewhat by several factors. Preliminary At the same time that the general trend of price indications are that growth in nominal GNP exceed increase is still slowing, there are indications that ed 11 percent in the second quarter. That high rate some of the cyclical influences that helped reduce in of spending growth is a welcome development in flation during the recession have waned. With sofar as it has come about in the context of ac demands for goods and services strengthening, price celerated real output growth and moderating prices. discounting is diminishing; and the downward However, growth in some measures of money and pressures on prices and wages in some markets will credit also has been relatively large recently, and lessen as orders and labor demand rise. Such growth in nominal spending at the present rate over a developments are to some extent inevitable. What is sustained period would suggest renewed inflationary of critical importance is that these cyclical influences pressures. not impair more lasting progress toward reduction in The vigor of the private economy at midyear also the underlying rate of inflation, as reflected in the has underscored the potential problems associated interactions of wages, productivity, and costs. with federal budget deficits that will remain massive in the years ahead, unless there are decisive actions to reduce expenditures or-absent such action-to increase revenues. Prospects for interest rates are Economic Projections for 1983 and 1984 FOMC Members Administration 1983 Range Central Tendency Nominal GNP 9¼ to 10¾ 9¾ to 10 10.4 Percent change, fourth quarter to Real GNP 4¾ to 6 5 to 5¾ 5.5 fourth quarter: Implicit deflator for GNP 4 to 5¼ 4¼ to 4¾ 4.6 Average level in Unemployment Rate 9 to 9¾ About 9½ 9.6 the fourth quarter, percent: 1984 Range Central Tendency Nominal GNP 7 to 10¼ 9 to 10 9.7 Percent change, fourth quarter to Real GNP 3 to 5 4 to 4½ 4.5 fourth quarter: I Implicit deflater for GNP 3¾ to 6½ 4¼ to 5 5.0 Average level in Unemployment Rate 8¼ to 9¼ 8¼ to 8¾ 8.6 the fourth quarter, percent: 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis related to a number of factors, including importantly indefinite future; as the private recovery lengthens, the actual and perceived trend in inflation. In 1982, the dangers associated with those deficits are likely when the economy was mired in recession and the to increase, posing a threat to both the inflation inflation rate was falling, record-large government outlook and the sustainability of a balanced deficits were consistent with declining interest rates. expansion. However, should public credit demands remain at or There also are some broader risks, not specifically near record highs while private credit demands are related to the budget, that some of the progress expanding rapidly in response to rising business ac against inflation could be reversed as the private tivity, the outlook for interest rates would clearly be economy strengthens. The persistence of inflationary affected. expectations is evident both in recent surveys of While most members of the Federal Open Market private opinion and in the behavior of financial Committee are relatively optimistic about the pro markets, in which borrowers remain willing to pay spects for maint.µning economic growth and contain high nominal rates of return on long-term debt in ing inflation over the next year and a half, they also struments. As the recovery progresses, wage and are mindful of potential difficulties that could disrupt price developments will need to be monitored with the outlook and cause the nation's economic perfor great care to make sure that these still-present ex mance to be less favorable than is now expected. pectations of inflation are not undergirding a new There is, as already noted, the prospect that federal round of acceleration in actual wage and price budget deficits will remain extremely large into the increases. More generally, the United States has become much more integrated into the world economy than it was a decade ago, and our economic fortunes have become closely linked with those of other na tions. Because of those close linkages, the economic difficulties of many foreign nations, particularly the serious financial problems still plaguing many developing countries, could affect this nation's economic performance in the period ahead. 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Footnotes 2. Base Period for Aggregates: For Ml-Fourth Quarter 1982. 1. Mt is the sum of currency held by the public, plus For M2-Average of February-March 1983. travelers' checks, plus demand deposits, plus other For M3-Fourth Quarter 1982. checkable deposits (including negotiable order of For Debt-December 1982. withdrawal (NOW and Super NOW) accounts, automatic Figures for "1983 Actual" are measured from base transfer service (ATS) accounts, and credit union share period through June 1983. Tentative ranges for M 1, M2 draft accounts.) and M3 1984 are measured from the fourth quarter of M2 is M 1 plus savings and small denomination time 1983 to the fourth quarter of 1984; debt is measured deposits, plus Money Market Deposit Accounts, plus from December 1983 to December 1984. shares in money market mutual funds ( other than those restricted to institutional investors), plus overnight repur 3. Base period is QII 1983. chase agreements and certain Eurodollar deposits. M3 is M2 plus large time deposits, large denomination term repurchase agreements, and shares in money market mutual funds restricted to institutional investors. Total Domestic Nonfinancial Sector Debt is outstand ing debt of domestic governmental units (federal, state and local), households and nonfinancial businesses. A copy of the full report to Congress is available free of charge from Publications Services, Federal Reserve Board, Washington, D.C. 20551. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testiniony of Paul A. Volcker, Chairman, Federal Reserve Board I welcome this opportunity to discuss reflected a cessation of inventory liquidation-and perhaps small accumulations-by business. That is Federal Reserve monetary policy with not unusual in the early stages of expansion, and the Banking Committee in the context does not necessarily suggest continuing gains at the same rate of speed. But it is also evident that of current and prospective economic domestic final sales and incomes are now increasing conditions and other policies at home fairly rapidly, that the midyear tax cut has released further purchasing power, and that consumer and and abroad. You have before you the business confidence has improved. Consequently, Midyear Monetary Policy Report to strong forward momentum has carried into the third quarter, and potentially beyond. the Congress prepared in accordance The expansion so far has been accompanied by with the Humphrey-Hawkins Act. remarkably good price performance. Finished pro ducer prices were essentially unchanged over the This morning, I will highlight or ex- first half of 1983, and consumer prices were up at a pand upon some aspects of that Report rate of only 3 percent through May and by about 3 ½ percent over the last twelve months. Perhaps and deal with certain further questions more significant for the future, the rate of nominal raised by your Chairman. wage increase-at about a 4 percent annual rate-is now at its lowest level since the mid-1960's, while average real wages, as in 1982, are rising. That pat tern has been assisted by sizable productivity gains. In all these respects, we are clearly "doing bet ter." Yet, even as the economy has expanded and the inflation record has remained good, widespread Course of the Recovery forebodings remain evident for the future. Those concerns are understandable and justified so long as We meet at a time when economic act.ivity is plainly some major. policy issues-issues that I emphasized advancing at a rate of speed significantly faster than in my testimony to you earlier in the year-remain we, the Administration, the Congress, and most unresolved. Indeed, the very speed and vigor of the other observers thought likely at the start of the recovery in its early stages has increased the urgency year. Over the past six or seven months of expan of facing up to those problems. sion, output has risen about as fast as in the average I have repeatedly expressed the view that we have postwar recovery, more than 1 million more people come much of the way toward setting the stage for a are employed, and the unemployment rate has drop long-sustained period of recovery, characterized by ped by nearly a percentage point from its peak. greater growth in productivity and real incomes and The very sizable gain in the Gross National Pro by much greater price stability. Responsible and duct during the second quarter in substantial part prudent monetary policies must be one important element in making that vision a reality. But it would be an illusion to think that monetary policy alone can do the job, and before turning to monetary policy in detail, I want to touch again upon some crucially important aspects of the environment in which monetary policy must be conducted. 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Budgetary Situation the problem would not become urgent until 1985 or I am aware of the enormous effort in the Congress beyond. That might be true in the context of a rather slowly growing economy. But the speed of the over recent months to shape a responsible budgetary current· economic advance certainly brings the day of resolution-indeed to preserve an orderly budgetary reckoning in financial markets earlier. In the second process. But the concrete results of that effort to date appear ambiguous at best, measured against quarter, total nonfederal credit demands were the challenge of reducing the growing structural already increasing substantially, even though business demands were essentially unchanged at a relatively deficits embedded in the current budgetary outlook. The current fiscal year is likely to see a budget low level. Potential credit market pressures have deficit-not counting Treasury or other market been ameloriated by a growing inflow of foreign financing of off-budget credit programs-of some capital, but a net capital inflow can be maintained $200 billion, or about 6 ½ percent of the GNP. only at the expense of a deep trade deficit. Banks Forecasts of future years necessarily entail judgments have been sizable buyers of government securities about Congressional action yet to be taken as well as during the early stages of recovery while business economic factors. Should Congress fail to implement demands for credit have been relatively slack. But the expenditure restraints as well as the revenue in there has also been some tendency for overall creases contemplated in the recent Budget measures of money, liquidity, and credit to rise Resolution-and doubt has been expressed on that recently at rates that, if long sustained, would be in point within the Congress itself-deficits appear like consistent with continuing or even consolidating pro gress toward price stability. ly to remain close to $200 billion for several years, even taking account of economic growth at the All of this, to my mind, points up the urgency of higher rates now projected. The hard fact remains further action to reduce the budgetary deficit to that, as economic growth generates income and ~ake ro~m for the credit needed to support growth revenues to reduce the "cyclical" element in the m. the private economy. Left unattended ' the situa- deficit, the "underlying" or "structural" position of t1on remains the most important single hazard to the the budget will deteriorate without greater effort to sustained and balanced recovery we want. reduce spending or increase revenues from that in corporated in existing programs. We would be left The International Dimension with the prospect that Federal financing would ab T~e pressur~s on our capacity to finance both rising sorb through and beyond the mid-1980's a portion private credit demands and a huge budgetary deficit of our savings potential without precedent during a have, as I just noted, been one factor inducing a period of economic growth. growing net capital inflow. One short-term conse That outlook raises a fundamental question about quence_ is lower domestic interest rates than might the consistency of the budget outlook with the kind otherwise be necessary, and maintenance of extraor- of economy we want. That is particularly the case t? with respect such heavy users of credit as housing and business mves_tment. To put the issue pointedly, the government will be financed, but others will be squeezed out in the process. While that threat has been widely recognized, there has also been a comfortable assumption that 9 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis dinary strength of the dollar at a time of rising trade process-with adequate resources to do its job would and current account deficits. But the sustainability deal a devastating blow to the extraordinary of those trends can be questioned. The picture of cooperative effort that has been marshaled to the largest and strongest economy in the world rely manage the situation, with potentially severe conse ing, in a capital-short world, on large inflows of quences for the U.S. financial system as well as the funds to finance, directly or indirectly, internal developing world. Early action by the House on the budget deficits is not an inviting one for the future. Administration's request in this matter is thus one The implication would be a persistently weak trade key element in a program to sustain recovery. position, instability in the international financial system and exchange rates, and lack of balance in Wage-Price Trends our recovery. More immediately, the pressing debt problems of I touched earlier on the relatively favorable wage much of the developing world-centered in, but not price-productivity trends of the past year. We are confined to, Latin America-remain a clear threat now approaching a new test-whether those trends to financial stability. In the period since we last can be extended into and through a period of discussed these issues, the strains have been suc recovery. Today, orders are rising, businesses are cessfully contained, but by no means resolved. To hiring, layoffs are sharply diminished, and profits be sure, there are clear signs of progress with are improving. After the inflationary experience of necessary economic adjustment in some instances the 1970's, the temptation could arise to revert to notably in Mexico. Within the past week, Brazil . what some might consider "normal" behavior-to which, along with Mexico, is the largest debtor-has anticipate inflation, to return to wage increases taken forceful and encouraging domestic actions that characteristic of the earlier decade, to fatten profit should provide a. base for renewed IMF support and margins as fast as possible by raising prices in a for added private financing. But ''normalcy'' has stronger market rather than relying on volume in plainly not returned. creases. But pressed collectively, the irony would be Confidence and market-oriented financing patterns that such behavior, by inciting doubts about the in cannot be fully restored without sustained growth flationary outlook and affecting interest rates, would among the industrialized countries, so that the deb impair prospects for continued growth in real wages, tors can earn their way with greater exports. Lower in profits, and in employment. interest rates will be important as well. But that pro We and other industrialized countries have had cess will take time. Meanwhile, failure to provide little. success in dealing with that threat through so the IMF- which is the international institution at called "incomes policies." But government policy the center of the adjustment and financing can make a powerful contribution toward modera tion through two avenues: first, by making evident in its fiscal and monetary management that infla tionary pressures will continue to be contained, and second, by insisting upon open, competitive markets. In that respect, open markets internationally serve our continuing basic interest in spurring efficiency and competition. Virtually every country has made compromises with protectionism during the period of recession. With growth underway, it is time not only to halt but to reverse that trend to help sustain ex pansion and the gains against inflation. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Moreover, as the economy grows stronger, I hope questions about interpreting some of the monetary we will seriously turn more of our attention to the and credit aggregates, judgments as to the ap many purely domestic inhibitions to competition, propriate degree of pressure on bank reserve posi and to reducing the artificial supports for prices and tions have been conditioned by available evideµce costs in some industries. All too often, they work at about trends in economic and financial conditions, cross purposes to the needs of the economy as a prices (including sensitive commodity prices), ex whole. change rates, and other factors. Through most of the first half of the year, as the economy picked up speed, the broader monetary Monetary Policy in 1983 and Beyond and credit aggregates moved consistently with the This setting of gratifying immediate progress, yet ranges set in February. At the same time, trends in evident looming threats, has provided the environ overall price indices were relatively favorable, and ment for decisions with respect to monetary policy. sensitive commodity prices, after an increase from As you are well aware, interest rates dropped sharp cyclically depressed levels early in the year, appeared ly during the second half of 1982 as the recession to be leveling off in the second quarter. The conti continued, and, with inflation subsiding, reserve nuing exceptional strength of the dollar in foreign pressures on the banking system were relaxed. exchange markets and the international financial Growth in money and credit has been, quite plainly, strains did not point in the direction of restraint. In adequate to support growth in economic activity all these circumstances, a broadly accommodative indeed more growth in the first half of 1983 than approach with respect to bank reserves appeared ap had been generally anticipated. propriate, despite much higher growth in Ml-alone During much of the period after mid-1982, in among the targeted aggregates-than anticipated. stitutional change, as well as adjustments by liquid In the latter part of the second quarter, against asset holders to the sharp drop in interest rates, to the background of growing momentum in economic declining inflation, and to the uncertainties of the activity, monetary and credit growth showed some recession, appeared to be affecting one or another of tendency to increase more rapidly, and M 1 growth the monetary aggregates. In particular, the behavior remained particularly high-higher, if sustained, of M 1 in relation to economic activity and the than seemed consistent with long-term progress nominal GNP has raised questions about whether against inflation and sustained orderly recovery. In the patterns in velocity established earlier in the these circumstances, the Federal Open Market Com- postwar period might be changing, cyclically or on a trend basis. For that reason, less emphasis has been placed on that aggregate in policy implementation. For a time, the enthusiastic reception of the public to-and aggressive marketing by depositary institu tions of-the new ceiling-free Money Market Deposit Accounts plainly affected· growth in M2. Consequently, the target base for 1983 for that ag gregate was set at the February and March average, rather than the fourth quarter of 1982, to avoid most of those distortions. More broadly, given the 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis mittee, beginning in late May, has taken a slightly and liquidity, given its inflationary potential. But I less accommodative posture toward the provision. of must emphasize again that the best assurance we bank reserves through open market operations, could have that monetary policy can in fact do its leading to some increase in borrowings at the dis part by avoiding excessive monetary growth within a count window. Whether viewed from a domestic or framework of a growing economy and reduced in international perspective, limited, timely and poten terest rates over time lies not in the tools of central tially reversible measures now, when the economy is banking alone, but in timely fiscal action. expanding strongly, are clearly pref<?rable to the risks of permitting a situation to develop that would Ranges for M2 and M3 require much more abrupt and forceful action later Looking ahead, the Committee decided that. the to deal with new inflationary pressures and a long growth ranges established early in the year for M2 sustained pattern of excessive monetary and credit and M3 during 1983 (7-10 percent and 6½-9½ growth. percent, respectively) are still appropriate. The most These steps have been accompanied by increases, recent data, while showing somewhat larger in ranging from ¾ to 1 percent or more, in both long creases in June, are still within (M2), or about at and short-term market interest rates. Apart from the upper end (M3), of those ranges. any monetary policy actions, these limited As anticipated, the massive shifting of funds into changes-particularly in the intermediate and M2 as a result of the introduction of Money Market longer-term areas of the market-appear also to Deposit Accounts, and to a more limited extent into have been influenced by larger private and govern Super NOW Accounts, has abated. We assume ment credit demands currently, as well as by expec these new accounts, and the further deregulation of tations generated by stronger economic and time deposit interest rates scheduled for October 1, monetary growth and the budgetary deficit. will have little impact on growth trends in the period Over the more distant future, balanced and sus ahead. Given the reasonably favorable trend of tained economic growth-with strong housing and prices, the ranges should be consistent with more business investment-would appear more likely to real growth than thought probable at the start of the require lower rather than higher interest rates. That year. outcome, however, can be assured only if the pro The Committee also decided to continue the gress against inflation can be consolidated and ex associated ranges for growth in total domestic non tended. In considering all these factors, the FOMC financial credit of 8 ½ to 11 ½ percent. As you basically concluded that the prospects for sustained know, 1983 is the first time the Committee has set a growth and for lower interest rates over time would range for a broad credit aggregate, and it is not be enhanced, rather than diminished, by modest and given the same weight as the broader monetary ag timely action to restrain excessive growth in money gregates, at least while we gain experience. We are aware that, consistent with the established range, growth in credit during 1983 could exceed nominal GNP, although the long-term trend is for practically no change in the ratio of credit to income (i.e., "credit velocity" is relatively flat). Somewhat faster growth in credit is consistent with experience so far this year, and may be related to the relatively rapid expansion in Federal debt. For 1984, the Committee tentatively looks toward a reduction of ½ percent in each of those ranges, for M2, M3, and non-financial domestic credit. That small reduction appears appropriate and desirable, taking account of the need to sustain real growth while containing inflation. Those targets appear fully 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis consistent, in the light of experience, with the looking ahead, with. the economy expanding and economic projections of the Committee (as well as with ample time for individuals and others to have those of the Administration and those underlying the adjusted to the rapid decline in interest rates last Budget Resolution). year, we must be alert to the possibility of a re The targets are, of course, subject to review bound in velocity along usual cyclical patterns, even around year end. One question that arises is though the longer-term trend may be changing. whether the somewhat more rapid growth in credit In monitoring Ml, the Committee felt that an ap than nominal GNP will, or should desirably, con propriate approach would be to assess future growth tinue, consistent with progress toward price stability from a base of the second quarter of 1983, looking and toward a more conservative pattern of private toward growth close to, or below, nominal GNP. finance than characteristic of the years of inflation. Specifically, the range was set at 5 to 9 percent for Again, the pressures on aggregate debt expansion the remainder of this year, and at 1 percent stemming from the budgetary situation are a source lower-4 to 8 percent-for 1984. Thus, the Commit of concern. tee, in the light of recent developments looks toward substantially slower, but not a reversal, of Ml Monitoring Ml and Debt growth in the future. Velocity is expected to in crease, although not necessarily to the extent com Decisions concerning appropriate targets for Ml mon in earlier recoveries. were more difficult. As discussed further in an Ap The range specified is relatively wide, but depen pendix to this statement, the velocity of M 1, ding on further evidence with respect to velocity, whether measured as a contemporaneous or lagged either the upper or lower portion of the range could relationship, has varied significantly from usual be appropriate. As this implies, Ml will be cyclical patterns, dropping more sharply and longer monitored closely but will not be given full weight during the recession and failing to "snap back" as until a closer judgment can be made about its quickly. While a number of more temporary factors velocity characteristics for the future. We are, of may have contributed, a significant part of the course, aware that proposals to pay interest on de reason appears to be related to the fact that a major mand deposits could, if enacted, influence velocity portion of the narrow "money supply" now pays in trends further over time. terest, and the "spread" between the return These targets are designed to be consistent with available to individuals from holding Ml "money" continuing growth in economic activity and reduced and market rates has narrowed substantially, more unemployment in a framework of sustained progress than the decline in market rates itself implies. Put against inflation-and indeed are designed, insofar another way, NOW accounts, where the growth has as monetary policy can, to contribute to those goals. been most rapid, are not only transaction balances, The targets, by themselves, do not necessarily imply but now have a "savings" or "liquid asset" compo either further interest rate pressures or the reverse in nent. For a time at least, uncertainty about the the period ahead-much will depend on other fac- financial and economic outlook, and less fear about inflation, may also have bolstered the desire to hold money. Growth in Ml-in running well above our targets for nine months-has not, however, been confined to NOW accounts alone. Moreover, there are signs that the period of velocity decline may be ending. In 13 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis tors. In particular, progress in the budget and con month period could be achieved by monetary policy, tinued success in dealing with inflation should be specific objectives might appear to assist in debating powerful factors reducing the historically high level and setting the appropriate course for monetary of interest rates over time, to the benefit of our policy. private economy and the world at large. Unfortunately, the premise of that approach is not valid-certainly not in the relatively short-run. The Federal Reserve alone cannot achieve within close ''Targeting'' Other E·conomic limits a particular GNP objective-real or Variables nominal-it or anyone else would choose. The fact The Chairman of the Committee has asked for my of the matter is monetary policy is not the only force views on the Federal Reserve's setting and announc determining aggregate production and income. ing "objectives" for a variety of economic variables. Large swings in the spending attitudes and behavior As you know, the FOMC already reports its ''pro of businesses and consumers can affect overall in jections" or "forecasts" for GNP, inflation, and come levels. Fiscal policy plays an important role in unemployment. These projections are included with determining economic activity. Within the last the materials I am reporting to the Committee to decade, we also have seen the effects of supply-side day, as they have been at earlier hearings. I believe shocks, such as from oil price increases, on ag the practice of reporting the full range and the gregate levels of activity and prices. In the last six "central tendency" of FOMC members' expecta months, even without such shocks, the economy has tions about the economy may be useful in reflecting deviated substantially from most forecasts, and from the general direction of our thinking, as well as sug what might have been set as an objective for the gesting the range of possible outcomes for economic year. performance in the 12 or 18 months ahead, given The response might well be "so what"-it's still our monetary policy decisions and fiscal and other better to have something to "shoot at." But en developments over those periods. couraging manipulation of the tools of monetary There is a sense in which those projections reflect policy to achieve a specified short-run numerical a view as to what outcome should be both feasible goal could be counterproductive to the longer-term and acceptable-given other policies and factors in effort. Indeed, we do want a clear idea of what to the economy; otherwise monetary policy targets "shoot at" over time-sustained, non-inflationary would presumably be changed. But I would point growth. But the channels of influence from our out that, like any other forecast, they are imperfect, actions-the purchase or sale of securities in the and actual experience has sometimes been outside market or a change in the discount rate-to final the forecast ranges. spending totals are complex and indirect, and Moreover, I believe there are strong reasons why operate with lags, extending over years. The attempt it would be unwise to cite "objectives" for nominal to "fine tune" over, say, a six-month or yearly or real GNP rather than "projections" or "assump period, toward a numerically specific, but necessarily tions" in these Reports. arbitrary, short-term objective could well defeat the longer-term purpose·. Proposal to Cite a GNP "Objective" Equally dangerous would be any implicit assump tion, in specifying an "objective" for GNP, that The surface appeal of such a proposal is understand monetary policy is so powerful it could be relied able. If a chosen path for GNP over a 6 to 18 upon to achieve that objective whatever else happens with respect to fiscal policy or otherwise. Such an impression would be no service to the Congress or to the public at large; at worst, it would work against the hard choices necessary on the budget and other matters, and ultimately undermine confidence in monetary policy itself. 14 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Some of the difficulties could, in principle, be met International Coordination by specifying numerical "objectives" over a longer Yo~r questions, Mr. Chairman, went on to raise the period of time. But, experience strongly suggests issue of international coordination of monetary that the focus will inevitably, in a charged political policy and whether or not to stabilize exchange rates atmosphere, tum to the short-run. The ability of the multilaterally. I can deal with these important issues monetary authorities to take a considered longer here only in a most summary way. , view-which, after all, is a major part of the Coordination, in the broad sense of working justification for a central bank insulated from par together toward more price stability and sustained tisan and passing political pressures-would be growth, is plainly desirable-indeed it m1;1st be the threatened. Indeed, in the end, the pressures might foundation of greater exchange rate and interna be intense to set the short-run "objectives" directly tional financial stability in the common interest. But in the political process, with some doubt that that stated so broadly, it is clearly a goal for economic result would give appropriate weight to the longer policy as a whole, not just monetary policy. run consequences of current policy decisions. The appropriate level of interest rates or monetary I would remind you that we have paid a high growth in any country are dependent in part on the price for permitting inflation to accelerate and posture of other policy instruments and economic become embedded in our thinking and behavior, conditions specific to that country. For that reason, partly because we often thought we could ''buy'' a explicit coordination, interpreted as trying to achieve little more growth at the expense of a little inflation. a common level of, for instance, interest rates or The consequences only became apparent over time, money growth, may be neither practical nor and we do not want to repeat that mistake. desirable in specific circumstances. What does seem Put another way, decisions on monetary policy to me desirable-and essential-is that monetary should take account of a variety of incoming infor (and other) policies here and abroad be conducted mation on GNP or its components, and give weight with full awareness of the policy posture, and possi to the lagged. implications of its actions beyond a ble reactions, of others, and the international conse short-term forecast horizon. This simply can't be in quences. In present circumstances, we work toward corporated into annual numerical objectives. that objective by informal consultations in a variety As a practical matter, I would despair of the abili of forums with our leading trade and financial part ty of any Federal Reserve Chairman to obtain a ners, recently on some occasions with the presence meaningful agreement on a single numerical "objec of the Managing Director of the IMF. tive" among 12 strong-willed members of the As this may imply, I believe a greater degree of FOMC in the short-run-meaningful in the sense of exchange market stability is clearly desirable, in the being taken as the anchor for immediate policy deci interest of our own economy, but that 'must rest on sions. Submerging differences in the outlook in a the foundation of internal stability. In recent years, statistical average would, I fear, be substantially less in my judgment, the priority has clearly had to lie meaningful than the present approach. with measures to achieve that necessary internal As you know, we adopted this year the approach stability. In specific situations, particular actions of indicating the "central tendency" of Committee thinking as well as the full range of opinion. These "estimates" provide, it seems to me, a focus for debate and discussion about policy that, in the end, should be superior to an artificial process of '' objec tive" setting that may obscure, rather than enlighten, the real dilemmas and choices. 15 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis may appear to conflict with the desirability of ex monetary policy, however conducted, can itself change rate stability; that possibility is increased substitute for budgetary discipline, for open and when the "mix" of fiscal and monetary policy is far competitive markets, for inadequate savings, or for from optimal, as I discussed earlier in my statement. ·structural financial weaknesses. Such "conflicts" should diminish as internal stability The world economy offers ample illustration of the is more firmly established. · dangers of procrastination and delay in the face of The idea of a more structured international political impasse, and in the hope that problems will system of exchange rates to enforce greater stability subside by themselves-only to be faced, in crisis in the international monetary and trading system circumstances, with the need for still stronger action raises issues far beyond those I can deal with here. I in an atmosphere of shattered confidence. That great do not believe it would be practical to move toward intangible of confidence, once lost, can only be such a system at the present time, but neither would rebuilt laboriously, step by step. I dismiss such a possibility over time should we and Here in the United States we have, with great ef others maintain progress toward the necessary fort, already gone a long way toward rebuilding the domestic prerequisites. foundation for growth and stability. We are not to day in crisis. The American economy-for all its difficulties-still stands as a beacon of strength and Stability and Sustained Growth hope for all the world. In important ways, even more progress toward our We know something of the risks and difficulties continuing economic objectives has been made dur that could tum the outlook sour. But I also know ing the past six months than we anticipated. But it that the actions necessary to make the vision of is also true-partly because economic growth has stability and sustained growth a reality are within increased-that the need to deal, promptly and ef our grasp. We have come too far, with too much ef- fectively, with the obstacles to sustained growth and . fort, to fail to carry through now. stability have become more pressing. Those obstacles are well known to all of you. There is, indeed, little disagreement, conceptually, about their nature. What has been lacking is a strong consensus about the specifics of how, in a practical way, to deal with them. There should be no assumption that 16 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Appendix Questions have been raised about the practicality of Consequently, the use of monetary and credit ag identifying a particular concept of money that has a gregates as guides for policy and in interpreting like stable relationship to broader economic objectives, ly economic developments requires continuing judg such as economic activity, prices, and employment, ment about the impact of emerging institutional and about the related issue of whether the recent developments and changing public preferences for "breakdown" in velocity behavior relative to money and credit demands, particularly.when the historical norms is temporary or longer-lasting. Both economic or financial environment has changed these questions bear directly on the role of monetary drastically. In that context, the value of the ag aggregates in the formulation and implementation of gregates for policy depends not so much on the monetary policy. "stability" of their relationships to other economic No single concept or definition of money or credit variables, but on the predictability of these relation aggregates can reasonably be expected always to ships, taking into account structural shifts that are provide reliable signals about economic performance, known to be in process. Monetary targeting is based or about the course of monetary policy and its rela on the presumption that structural changes will not tion to the nation's basic economic objectives of sus be so rapid or so unpredictable as to undermine the tainable economic growth, high employment, and usefulness of the aggregates as annual targets, stable prices. One reason is that market innovations although over time they may need to be adapted to and regulatory changes can alter the significance of ongoing behavioral changes. the various aggregates at different times. Usually, For the past decade or so a series of institutional however, such changes take place gradually without changes have affected the meaning and interpreta basically altering relationships over the shorter-term. tion of the several monetary aggregates. Around the On occasion, their impact may be more sizable and mid-1970s, various instruments and techniques abrupt, both in terms of influence on measured began to be developed in financial markets that monetary aggregates and their relation to over-all enabled depositors to economize on holdings of cash economic performance. Definitions of the monetary and to earn interest on highly liquid balances that to aggregates can be, and have been, adapted to some extent substituted for cash. This new financial significant institutional changes, although all defini technology, abetted by legislative and regulatory tions of "money" necessarily involve at the margin changes that permitted depository institutions to a degree of arbitrariness. The various money and compete more effectively, changed the shape of near-money assets often serve a variety of functions financial markets. The Federal Reserve adapted its for their holders that cannot be precisely distinguish ed statistically. Even in the absence of institutional changes in financial markets, changes in the public's desires to hold liquidity as compared with "normal" past pat terns can, through impacts on velocity, alter growth rates in the aggregates that may be consistent with broader economic developments. These shifts in li quidity preference historically have occurred during periods characterized by unusual economic uncer tainties associated with such developments as pro tracted economic weakness, fears of inflation, or in stability in the financial system. 17 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis definitions of monetary aggregates to the emerging whether velocity is measured contemporaneously as institutional structure. the relationship of GNP to money in the current The narrowest definition of money-M 1-was quarter or is measured on a lagged basis as the rela designed to measure transaction balances, and thus tionship of GNP to money one or two quarters could be expected to bear a closer, more predictable earlier. This occurred as the share of NOW ac relation to aggregate spending than,. the br9ader counts in the aggregate expanded, as financial measures, which were affected as well by attitudes markets adjusted to lower rates of inflation, and as toward saving and wealth. The measure of Ml was economic uncertainties were heightened during the redefined a few years ago in light of institutional recent period of economic contraction. The unusual changes to encompass transaction-type balances held ly large and sustained drop of M 1 velocity may in in forms other than demand deposits. In particular, the circumstances in large part reflect an enhanced interest-bearing savings accounts subject to a demand for M 1 that arose from the decline in infla regulatory ceiling rate but with checkable features tion and the related sharp fall in market interest (such as regular NOW accounts) were included in rates during the second half of 1982. The availabili the measure, and later such accounts ·t hat could pay ty of interest-bearing NOW accounts may have a market rate were also added (super-NOW ac made depositors even more willing to hold funds in counts). However, these accounts served broader Ml-type accounts as market interest rates declined. purposes for their holders than simply facilitating In addition, Ml was probably boosted by heighten transactions. They also were an attractive repository ed savings and precautionary demands. These sav for longer-term savings. Thus, interpretation of Ml ings demands originally manifested themselves in the was affected, and made less certain, especially over contractionary phase of the current economic cycle, the pasf year or more, by its changing character; but apparently have to a degree continued into the and the weight. placed on this aggregate in policy expansion phase. implementation was necessarily altered during such The "breakdown" in the pattern of the velocity of periods of transition. Ml, in the sense of its unusual behavior during the Over the last several quarters, the income velocity current economic cycle, may well be· abating. Its in of Ml has fallen considerably and been much come velocity declined much less in the second weaker than experience over comparable stages of quarter of this year than it had over the previous post-war business cycles would have suggested, five quarters-which may suggest that velocity is beginning to move back toward a more familiar and predictable pattern of behavior. Of course, the radical change in composition of Ml over the past two and a half years-with interest-bearing NOW accounts ( some subject to ceiling rates and some at market rates) presently representing about one-third of the deposits included in Ml, a share that will probably grow-suggests that the pattern of Ml velocity, even after a transition period, may come to vary from what it had been in the past. While the relatively short experience with an Ml measure that includes a prominent savings compo- 18 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis nent (NOW accounts) tends to heighten uncertainty With regard to credit, institutional developments, when predicting velocity behavior, it is by no means the process of deregulation, and the emergence of clear that our understanding of emerging velocity innovative financing techniques in bond and other trends will be so limited as to preclude reasonable markets have contributed to reducing the special estimates of the outlook for velocity. Efforts to re significance of bank credit as the cutting edge of estimate money demand equations in light of recent changes in credit availability. As a result, more institutional developments have helped explain a weight has been placed on a broad measure of total considerable part of recent velocity movements, and credit-in particular, the aggregate debt of domestic can be expected to be of assistance in projecting nonfinancial sectors-for helping to track credit velocity. needs as related to the overall economy and to guide Institutional changes have also affected the monetary policy in that respect. broader aggregates-M2 and M3-and they have In brief, .several money and credit measures taken been redefined as necessary to incorporate new in as a group, together with an updating of definitions struments, such as money market funds, repurchase and measurement techniques as needed, can serve, agreements, Eurodollars, and money market deposit and have served, as a useful guide for monetary accounts. With the definitional coverage of broad policy; and in the light of a long sweep of history money measures enlarged, they encompass a very cannot be ignored. While it is true individual ag wide spectrum of liquid assets, so that these gregates from time to time may be distorted by measures would tend to be less distorted than M 1 special developments and may not readily track the by financial innovations and shifts of funds among performance of the economy, the presumption re various liquidity instruments. Very large shifts of mains of a longer-term stability and predictability in funds, as were associated with the introduction of relationships. MMDAs, could distort particular money measures for a relatively short time, as was the case par ticularly for M2 in early 1983. While the velocity of M2 departed from historical norms during the past several quarters, it did so to a lesser degree than Mt. During the recent downturn M2 velocity declined only somewhat more than it had in past cyclical contractions on average. Thus far in the recovery phase of the cycle, the velocity of M2 has turned upward on average ( after rough allowance for the distorting influence of shifts associated with the introduction of MMDAs) within the range of experience of previous cyclical expansions. 19 l'BB f-60000-0783 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1983, July 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19830720

@misc{wtfs_monetary_policy_report_19830720,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1983},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19830720},
  note = {Retrieved via When the Fed Speaks corpus}
}