Monetary Policy Report

Monetary:P o_liCr -. ·. · Ohj~ctives _f o.r 1984 v Midyear Review of the Federal Reserve Board . - ( July 25, 1984 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy Objectives for 1984 With Tentative Monetary Growth Ranges for 1985 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. July 25, 1984 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy in 1984 and 1985 1 The Growth of Money and Credit 1 The Outlook for the Economy 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy • 1984 and 1985 In The Growth of Money and Credit somewha_t. However, given the levels of the money and credit aggregates at midyear, it is unlikely that At its July meeting, the Federal Open Market Com M3 and debt will be within their ranges by year mittee reviewed its target ranges for 1984 and estab end, although it is expected that some deceleration lished tentative ranges for 1985 in light of its objec toward the upper limits of the ranges will occur. tive of achieving sustained growth in the context of Under the circumstances, the Committee consid continuing progress toward reasonable price stability ered the question of whether increases in the ranges over time. The behavior of M1 and M2 in the first for 1984 for M3 and domestic nonfinancial sector half of 1984 was broadly consistent with the Com de_bt would be appropriate. On balance, the Com mittee's expectations and objectives, and the Com mittee was of the view that the direction of policy mittee reaffirmed the existing target ranges for 1984 would best be communicated by retaining the cur for those aggregates. rent range for M3 and the associated monitoring M3 expanded above its target range and domestic range for domestic nonfinancial debt. While the nonfinancial sector debt ran well above its monitor Committee anticipated growth somewhat above their ing range during the first half of the year. It appears ranges for the year as a whole, it was felt that that the factors that led to growth in M3 and debt higher "target" ranges would provide an improper above the upper limits of their ranges in the first benchmark for evaluating desired longer-term trends half could be less important during the second half. in these aggregates. Credit flows associated with corporate acquisition ac The Committee reaffirmed its intention to lower tivity should diminish, partly because of higher over time the growth of money and credit to rates prevailing interest rates and partly because of app~opriate to progress toward price stability in an greater caution on the part of lenders in evaluating environment of sustainable economic growth. Con the soundness of proposed transactions. It also seems sistent with these goals, the FOMC established ten likely that growth of household spending and con tative ranges for 1985 for M 1 and M2 that were sumer and mortgage credit demands will moderate somewhat below those for 1984, as shown below. Ranges of Monetary Growth 1984 and 1985 1 1984 Range2 1984 Actual2 1985 Tentative 2 Percent Percent Percent Ml 4 to 8 7.5 4 to 7 M2 6 to 9 7.0 6 to 8½ M3 6 to 9 9.7 6 to 9 Total Domestic Nonfinancial Sector Debt 8 to 11 13.13 8 to 11 Digitized for FRASER 1 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The width of the Ml range was brought more in The Committee retained the current target range line with the dimensions of the ranges for the other for M3 and the current monitoring range for domes aggregates. This reflected experience over the past tic nonfinancial sector debt for 1985. As noted, these year in which the behavior of Ml has been more aggregates might be somewhat above their ranges in consistent with previous cyclical experience than was 1984. Thus, growth next year within their ranges the case in the recent recession. Consequently, the would represent an actual slowing from this year's pace. The Committee noted that some deceleration in growth of these aggregates is both desirable and Mt Billions of dollars likely, reflecting a slowing in expansion of nominal GNP and a drop in corporate merger activity. Still, --Range adopted by FOMC ..-8% business demands for external finance are likely to for 1983 Q4 to 1984 Q4 ........ 560 remain strong; although household borrowing is ex .... .... pected to moderate somewhat in 1985, state and lo ......... / cal government borrowing may be heavier than in ,,, 550 1984 and the federal budget implies the continuation .,.4% of exceptionally large Treasury borrowing . -- - .,. .,. .,. - 5 40 The Committee noted that only limited progress ---- -- has been made recently in reducing federal budget -- deficits, and that current and prospective structural 530 Billions of dollars --Range adopted by FOMC .,.9% for 1983 Q4 to 1984 Q4 / 1983 1984 ........ 2350 / .... / / 6% Committee felt that it would be appropriate to give .... / ,,,.,,, 2300 roughly equal weight to all of the monetary ag gregates in implementing policy. Nonetheless, it was recognized that uncertainties remained about the be 2250 havior of Ml, as well as of the other aggregates, m periods of changing market conditions. 2200 Digitized for FRASER https://fraser.stlouisfed.org 2 Federal Reserve Bank of St. Louis M3 Billions of dollars reversing the debilitating trends of rising inflation and languishing productivity that plagued our econ --Range adopted by FOMC omy for so many years. But monetary vigilance-in for 1983 Q4 to 1984 Q4 combination with determined action to reduce the 9% ,,,,,,,, 2900 federal presence in the credit markets-is essential to the achievement of durable reductions in interest -- rates, overall financial and economic stability, and -6% sustained growth of the economy. - --- 2800 --.,.,.- -- _.,.,. -_.,.,. Domestic N onfinancial -- Sector Debt Billions of dollars 2700 --Range adopted by FOMC for 1983 Q4 to 1984 Q4 ,,,,,, ,,, 11 % ,,, ,,,,,, 5600 1983 1984 ,,,,,, ,,,, 8% "'~,,,,,.,,--"'"'- deficits remain huge. The massive fiscal stimulus ~ 5400 and credit demands associated with these structural deficits will tend to hold interest rates at high levels. Further progress in lowering the deficit would be a 5200 factor tending to relieve credit market pressures. The Committee felt that implementation of mone tary policy would require the continuing appraisal of the progress of economic activity and prices and of conditions in domestic credit and international finan 1983 1984 cial markets-especially in light of the sensitive state of these markets and of a number of economic sec tors. The Committee emphasized, however, the im portance of appropriate restraint in money and credit growth. A good start has been made in Digitized for FRASER 3 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Outlook for the Economy capital inflows. Interest rates, under pressure from the combined credit demands of the federal govern The nation's economy in the first half of 1984 was ment and the rapidly growing private sector, have characterized by marked strength in sales, produc rise~ from what were already high levels historically, tion, and employment and by relatively low infla addmg to stresses on some sectors of the domestic tion. Moreover, economic activity appeared to have economy and on heavily indebted foreign countries. substantial forward momentum at mid-year, and the As labor and capital resources have become much strong growth of the U.S. economy was helping to more fully utilized, and as real growth has continued encourage recovery abroad as well. Amid the favor exceptionally rapid, the possibility of demand pres able overall performance, however, some important sures contributing to renewed inflationary tendencies structural imbalances and financial strains were ap has become a concern to many. parent that need attention lest they impair the sus For the near term, the prospects for continuing tainability of orderly growth. In particular, extraor good gains in economic activity appear favorable. dinary increases in domestic demand have been Consumers seem to be willing to spend, and they accompanied by a further deterioration of our trade have the wherewithal to do so. The rising trend of and current account deficits, which has contributed contracts and orders points to further sizable in to dangerous protectionist pressures. The persistent creases in business plant and equipment spending. strength of the dollar in foreign exchange markets has helped to keep inflation quiescent, but that strength has been dependent on a pattern of massive Economic Projections for 1984 and 1985 (percent) FOMC members and other FRB Presidents 4 1984 Range Central Tendency Nominal GNP 9½ to 11½ 10½ to 11 Change, fourth quarter to fourth Real GNP 6 to 7 6¼ to 6¾ quarter: Implicit deflator for GNP 3¼ to 4½ 4 to 4½ Average level in Unemployment Rate 6½ to 7¼ 6¾ to 7 the fourth quarter: 1985 Range Central Tendency Nominal GNP 6¾ to 9½ 8 to 9 Change, fourth quarter to fourth Real GNP 2 to 4 3 to 3¼ quarter: Implicit deflator for GNP 3½ to 6½ 5¼ to 5½ Average level in Unemployment rate 6¼ to 7¼ 6½ to 7 the fourth quarter: Digitized for FRASER 4 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis And inflation should remain relatively subdued in Change from end of previous period, Consumer Price Index the period immediately ahead, given the recent annual rate, percent behavior of labor and material costs. However, beyond the near term, the stresses and imbalances in the economy give rise to signif-::ant 15 uncertainties in assessing the economic and price outlook-and pose substantial challenges for public policy. The members of the Federal Open Market Committee emphasized that the probability of main 10 taining highly satisfactory performance could only be assured by timely decisions in a number of public policy areas. In formulating its own policy plans, the Committee agreed that, while flexibility and sensitiv I HI 5 ity might be required in conducting monetary policy during this crucial period, Federal Reserve policy would need to remain basically oriented toward en iJ!!iJijlilil couraging growth in a context of maintaining pro 1978 1979 1980 1981 1982 1983 1984 gress over time toward price stability. remainder of 1984, but with growth of real GNP Change from end of previous period, less rapid than in the first half of the year. While Real GNP annual rate, percent clear evidence of substantial moderation in the pace of expansion is still limited, some slowing seems likely in light of some softening of demand in the 8 housing market, some probable tendency for inven tory investment to level off after a sharp surge in the ilil first half, and other factors. f 4 Members of the FOMC believe that growth in ac tivity is likely to continue in 1985, though at a slower pace. That slower pace would be satisfactory + to the extent it reflected the settling of the economy into a sustainable pattern of longer run expansion 1978 1979 1980 1981 1982 1983 1984 Exchange Value of the U.S. Dollar Index, March 1973 - 100 At this time, the members of the FOMC (together Trade Weighted Average with other Reserve Bank presidents) generally fore see appreciable gains in economic activity over the 130 110 90 1978 1979 1980 1981 1982 1983 1984 Digitized for FRASER 5 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis after a rebound from an exceptionally deep reces Footnotes sion. The Committee expects price increases to be 1. Ml is currency held by the public, plus travelers' checks, somewhat larger in 1985 than this year, on the as plus demand deposits, plus other checkable deposits (including sumption that the dollar remains in the trading negotiable order of withdrawal (NOW and Super NOW) ac range of the past year or so; the expectation of some counts, automatic transfer service (ATS) accounts, and credit pickup in price increases reflects in part the assump union share draft accounts.) tion that the inflation-damping influence of the ap M2 is Ml plus savings and small denomination time deposits, preciation of the dollar will abate, but that some plus Money Market Deposit Accounts, plus shares in money cyclical pressures on wages and prices might also be market mutual funds ( other than those restricted to institutional anticipated as a result of reduced slack in labor and investors), plus overnight repurchase agreements and certain product markets. Eurodollar deposits. M.3 is M2 plus large time deposits, large denomination term The behavior of the dollar in foreign exchange repurchase agreements, and shares in money market mutual markets is only one of the uncertainties in the out funds restricted to institutional investors. look for 1985. Strains in financial markets have been Total Domestic Nonfinancial Sector Debt is outstanding aggravated by the historically large current and debt of domestic governmental units (federal, state and local), prospective federal budget deficits, and international households and nonfinancial businesses. debt problems will continue to require attention. 2. Ranges for the aggregates are measured from fourth quarter With respect to the federal budget, Committee to fourth quarter. "Actual" figures for 1984 are measured from members are assuming that Congress and the Ad fourth quarter 1983 to June 1984. ministration will soon complete action on a series of 3. Estimated. measures that represent an initial "down payment" 4. Administration budget review documents were not available at the time of this Report. toward reducing current and prospective federal budget deficits. Although no specific assumptions were made regarding further deficit-reducing steps in 1985, it was recognized that additional, substan tial budgetary actions will be needed to enhance the prospects for sustained, orderly economic growth. U.S. Current Account Billions of dollars + 25 !1111 50 75 QI 1978 1979 1980 1981 1982 1983 1984 A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRB6-55000-0784 Digitized for FRASER https://fraser.stlouisfed.org 6 Federal Reserve Bank of St. Louis Monetary Policy Objectives for 1984 Testimony of Paul A. Volcker, Chairman, Board of Governors of the Federal Reserve System. July 25, 1984 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Paul A. Volcker, Chairman, Federal Reserve Board I appreciate the opportunity to appear new expansion phase, the pace of growth would once again before this Committee to re slow. But in fact growth actually accelerated as we moved into this year. During the second quarter of view monetary policy in the context of 1984, the economy as a whole operated at a level our overall economic performance and more than four percent higher than in the closing months of last year and 7 ½ percent higher than a problems. In accordance with the year earlier. Humphrey-Hawkins Act, the semi Almost three million more people have been em annual report of the Federal Reserve ployed so far this year, bringing the total gains over the past 18 months close to 7 million. The un Board reviewing economic developments employment rate has dropped to about 7 percent. and the decisions of the Federal Open Business investment has risen very rapidly this year, while consumer spending has remained Market Committee with respect to mone strong. The forward momentum of the economy tary and credit targets for 1984 and still appears considerable. At the same time, inflationary pressures have to 1985 was transmitted to you this morn this point remained subdued, with most summary ing. As indicated there, the FOMC prict' measures rising little, if at all, faster than the reaffirmed the target and monitoring sharply reduced rate of 1983. In fact, a number of sensitive commodity prices have dropped recently, i ranges for the various monetary and following sizable cyclical increases. Highly competi I credit aggregates for 1984 and decided to tin: domestic and international markets, influenced by the strength of the dollar overseas and continued reduce the top end of the ranges for M 1 I strong efforts to discipline costs, have been key fac • and M2 for 1985. I will discuss that tors contributing to greater price stability. The net later in my testimony. First, I would result has been rising productivity and good gains in real incomes, even while nominal wage and like to summarize some key points about i salary increases have remained moderate. the economy and call your attention to I ,ooking only at these overall measures, this i recovery and expansion period has been atypical particular problems that present clear atypical in the sense that such a rapid expansion risks to an otherwise positive outlook. has been maintained longer after the recession trough than in any comparable cyclical period since vVorld War II, excepting only the Korean War epi soclc. But the period has been atypical in other ways as well-in ways that potentially could have The Overall Economic Performance · severely adverse implications unless dealt with by Measures of aggregate economic activity, employ timely and effective policy actions. ment, costs, and prices have provided an almost . unbroken string of favorable news so far in 1984. Imbalances and Strains , The process of recovery from the deep and pro- , longed recession-a recovery that began amid wide 111 any period of recovery and expansion, some sec ; spread doubts about both its potential vigor and tms fan· relatively better or worse than others, and ; staying power-had proceeded strongly through in that general respect this period has been no ex- i 1983. There were widespread anticipations early < cption. Some of our heavy industries-for in i this year that, as we moved bcvond rccoH'ry into ,1 ·(fa!HT. stcd and other metal:,; and heavy machin- Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ery-are still at operating rates well below earlier The strong dollar and the ample availability of experience. Demand for our agricultural products goods from abroad at a time when growth in most from abroad has not been buoyant, and many other developed countries has been relatively slug farmers-particularly those with large debts-are gish have certainly been potent forces helping to being severely squeezed by high interest rates and contain inflation. The capital inflow, supplementing falling land prices. our net domestic savings by a quarter, has been a What is different, in degree and in kind, is that factor containing pressures on our own financial some inevitable unevenness in patterns of growth in markets. And, the large rise in our imports has particular sectors has been aggravated by the mas helped stimulate economic activity among some of sive and related imbalances in both our fiscal posi our leading trading partners and eased somewhat tion and our international trading accounts and by the severe adjustment process underway in Latin some strains in financial markets. As you know, America. rapid growth has been reflected in some reduction But what is in question is the sustainability of in the budgetary deficit, estimated for fiscal 1984 in that process, as the United States becomes more the neighborhood of $170-$175 billion. The Con and more dependent on foreign capital, as our ex gress is in the process of enacting the so-called port and import-competing industries are damaged "downpayment" against future deficits, part of and seek protectionist relief, and as interest rate which has already been signed by the President. pressures remain strong. The only real question is But the hard fact is, as I am sure the Congress is whether the needed and inevitable adjustments will fully aware, the deficit remains huge in absolute be facilitated and encouraged by constructive public and relative terms, and absent further action little policies, consistent with long-term growth and sta or no further decline now seems probable for 1985 bility, or whether we are content, despite all the and beyond, even assuming the economy continues strains and dangers, to let events simply take their to move to "full employment" levels. course. Short-sighted relapses into lack of financial That circumstance has been reflected in con discipline, widespread protectionism, and wage and tinued large Treasury borrowings, and expectations pricing excesses could only aggravate the situation. of indefinite continuation. Meanwhile, private credit It is, in the end, the choice between building on demands, responding to and supporting growth in the enormous progress of the past to achieve sus consumption and investment, have acceleratc-d. Per tained growth in a framework of greater stability or sonal savings relative to income have rcmainc-d in a relapse into inflationary economic malaise. With the lower range characteristic of the late 1970s, and that choice clear, I am confident that the needed despite growth in internally generated corporate policies are well within our collective grasp. cash flows, the sources of domestic funds have The continuing difficulties of some heavily in fallen far below our demands. In these circum debted developing countries in Latin America, and stances, interest rates-already historically high in some other places as well, has been one point of tended to move still higher during the spring. uncertainty. A sense of greater concern has, ironi Those high interest rates, combined with favorable cally, come at a time when several of the largest economic conditions generally in this country, have borrowers have more clearly made substantial pro attracted more and more capital from abroad to gress toward reducing external financing require help meet our domestic needs. and the dollar has ments and toward carrying out the more fun appreciated despite deterioration in our trade and damental adjustments that should provide a firm current accounts. base for their renevvcd growth. But other borrowing 1 nations have made less progress, and the uncertain- 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ties have been fed by signs of growing protec ward providing enough money to support sustain tionism in industrialized countries and by the in able growth while continuing to encourage greater creases in interest rates in the United States which price stability over time. As detailed in the full re impact directly on debt service costs of countries port, Committee members felt that broad objective with large external dollar-denominated debt. was consistent with the growth ranges for money Within the United States, the relatively high level and credit specified in February for this year, and of interest rates has aggravated financial pressures no changes were made. For 1985, the tentative de in the farm sector. Many thrift institutions face the cision was reached to reduce the ranges slightly for prospect of weak earnings at a time when capital both M 1 and M2, specifically by lowering the top positions have been eroded by losses earlier in the end of the ranges specified for this year by 1 % and decade. And, despite the rapid growth of the econ 1/2 % , respectively. The target range for M3 and omy and strong increases in business profitability the monitoring range for domestic credit were left overall, more stable prices have exposed some unchanged. These tentative decisions for 1985 will weaknesses in credit practices in the energy and be carefully reviewed at the start of next year. other areas encouraged by earlier inflationary ex In assessing the appropriate ranges, and the rela pectations. tive weight to be placed upon the various ag gregates, the Committee reviewed the evidence of more typical cyclical behavior of M 1 in recent Monetary Policy quarters relative to GNP, following the unusual be These developments have provided the setting for havior of velocity in 1982 and early 1983. In the the implementation of monetary policy thus far in light of that examination, it felt that roughly equal 1984 and for the review of monetary and credit ob weight should be given each of the monetary ag jectives by the Federal Open Market Committee for gregates in implementing policy. However, ap this year and next. praisals of their movements, and relationships In reaching its policy judgments, the Committee among them, will continue to be judged in the light members shared the widespread view that the over of developments in economic activity, inflationary all rate of economic growth would moderate soon pressures, financial market conditions, and the rate as resources become more fully employed and of credit growth. would continue through 1985 at a sustainable pace. While both M 1 and M2 have grown within their While the rate of price increase has been somewhat targeted ranges of this year, 4 to 8 percent and 6 , slower than expected over the first half of 1984, to 9 percent respectively, M3 and particularly that rate is generally expected to rise by a percent domestic credit, have expanded faster than antici age point or so next year, assuming that the dollar pated. Credit growth has, in fact, continued to out remains in the same general range as over the past pace that of nominal GNP, as was the case last year. In making those projections, Committee year but contrary to longer-term trends. Viewed in members also noted that continued high budget a medium-term vr longer perspective, those growth deficits and other factors, unless dealt with effec rates for M3 and domestic credit are higher than tively, would pose substantial risks of less satisfac consistent with sustainable rates of growth in the tory results with respect to economic activity or economy and progress toward price stability. For prices or both. that reason, the Committee decided not to raise the The economic projections, of course, took ac target ranges for this year, feeling that would pro count of the decisions made on monetary policy. vide an inappropriate benchmark for measuring Broadly, monetary policy will remain directed to- desired long-run growth, even though Committee members recognized that, as a practical matter, growth in these aggregates, at least for domestic credit, would likely exceed the specified ranges. 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In reaching those judgments, the Committee Typically, Federal deficits shrink substantially as recognized that the rate of business credit growth the economy moves into the second and third years had been amplified by an unusual spate of merger of expansion-there was a day when balance or activity and corporate financial reorganizations-so surplus was the reasonable objective. That is not called "leveraged buy-outs"-that had the effect of happening this time. And in contrast to 1982 and substituting debt for equity. The implications of most of 1983, Treasury must compete strongly with those financings, while potentially adverse from the accelerated demands for consumer and business standpoint of the overall financial strength of partic credit and a continued high level of mortgage bor ular businesses, are relatively neutral from the rowmg. standpoint of demands on real resources and overall With long-term markets unreceptive, much of the credit market conditions. Estimated adjustments for increase in business and consumer borrowing is be that activity on the rate of overall credit growth ing done at banks. Thrift institutions remain highly would reduce the indicated expansion over the first active in the mortgage markets. These institutions, half of the year from a rate of about 13 percent to in turn, rely increasingly on certificates of deposit 12 percent, closer to, but still above, the monitor and other forms of market finance included in the ing range. That growth, together with the extraor M3 aggregate, accounting for its relative strength. dinary rise in consumer and Federal Government In implementing the policies reflected in the vari debt, is shown in the Tahle. ous targets, steps were taken during the late winter and early spring to increase somewhat pressures on bank reserve positions, and the discount rate was Growth in Domestic Nonfinancial Debt raised once, from 8½ % to 9%. Reserve pressures (Seasonally adjusted annual rates. percent) have not changed appreciably since that time, as reflected in relatively unchanged borrowings at the QIV: 1983 discount window ( apart from those by the troubled to QII: 1984 1 Continental Illinois Bank). With both M1 and M2 remaining within their target ranges, and against Total 13.!2 the background of the economic, price, and finan Federal 14.6 cial market developments reviewed earlier, stronger restraining actions on money and credit growth Other 12.6 generally have not appeared appropriate. At the same time, the relatively rapid rates of growth in Selected Categories 1\13 and domestic credit are flashing cautionary sig nals. Home Mortgages 11. 7 \Vhile pressures on bank reserves did not in Consumer Credit 18.4 crease further, both long- and short-term interest rates rose over the spring. The continued heavy Short-term Business Borrowing 15.6 credit demands, expectations that those demands would persist against the background of the huge 1 Hase<l on quarterly avt'rage flow of funds data. QIL 1984 partly i•!.;timated. federal deficit and strong economic expansion, and 1 Adjusted for the (fniit used in corporate mergers and buy outs, it is t~sti fears of a resurgence of inflationary pressures as matt·d 1hat growth in domestic nonfinandal debt W(HAld be about 1'2 percent (SAAR) o\'cr th,· lirst half pf 198+ both labor and capital are more fully employed all played a part. In more recent weeks, rates have tended to stabilize at high levels, perhaps partly be- 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis I cause current price trends have, at least so far, not The problems of Continental Bank essentially borne out more extreme inflationary concerns ex reflected serious weaknesses in the domestic loan pressed earlier. Nonetheless, markets remain volatile portfolio of a bank that had engaged in aggressive and apprehensive. growth and lending practices for some time, includ ing heavy involvement in participations in energy loans of the Penn Square Bank that failed two International and Domestic Banking Markets years ago. As other credit losses surfaced and earn The atmosphere surrounding credit and banking ings pressures continued, market sources of funding markets at times during recent months has been were reduced and the bank became heavily depen appreciably influenced by the apparent difficulties of dent on discount window borrowings during the one of the nation's largest banks and by continuing spring. As the atmosphere surrounding the bank concerns over the ability of some developing coun deteriorated and threatened to disturb markets more tries to service debts held mainly by large commer generally, the supervisory authorities, together with cial banks around the world. a group of other major banks, provided a massive As I have reported to the Committee before, or financial assistance program pending a more per derly and full resolution of the latter problem will manent solution. I believe those more lasting ar require a strong cooperative effort by borrowers rangements will be announced shortly, and will and lenders alike over a considerable period of provide a firm base for a healthy, but considerably time. I noted there are, in fact, encouraging signs smaller bank. that the difficult process of internal and external ad That situation is unique for a large bank, but the justment is beginning to bear fruit in important episode may be an object lesson about the impor countries in Latin America, including Mexico, tance of looking ahead to anticipate problems. Venezuela and Brazil. Negotiations are currently In a period of rapid economic and credit expan underway by the first two of those countries with sion, there can be temptations to relax prudent banks looking toward a long-term restructuring of credit standards in an effort to maximize growth. their external debt at terms reflecting the evidence With deposit markets deregulated, there may be a of prudent policies and improving credit-worthiness. perception by individual banks that added funds Provided that growth is maintained in the industri can be raised as needed in domestic or foreign alized countries and markets for their products are markets by bidding rates higher to fund larger and not closed, prospects for economic recovery and larger loan portfolios-and that loan rates can be growth on a sustainable basis in those Latin Ameri raised as fast as deposit rates. But the aggregate can countries appear more favorable, helped to a supply of funds is ultimately not really inexhausti substantial extent by the growth in our own mar ble; confidence must be maintained, and high and kets. In other countries the adjustment process is volatile interest rates can undermine the credit less advanced, but the progress of some, both in worthiness of weaker borrowers. adjustment and financing, can point the way for When external economic developments and high others. While the challenge for all remains substan interest rates impair the ability of otherwise credit tial, we need to view it realistically, as a situation worthy borrowers fully to maintain scheduled debt that justifies neither neglect nor despair. Rather, service on loans made earlier in a different eco appropriate approaches tailored to the needs of each nomic environment, prudent banking may indeed country can bring results. But with that effort on suggest forebearance and renegotiation of outstand all sides, the problem is manageable. ing loans. We, for instance, have introduced super visory procedures to assure that examiners refrain from criticizing banks for exercising forebearance 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis on agricultural credits when consistent with safety sponsored by this Committee last year and, so far and soundness. I also believe that, when heavily in as holding companies are concerned, with the spirit debted countries are moving aggressively to im of the provisions touching upon capital in S. 2851. prove their credit-worthiness, restructuring of for In that connection, I would also emphasize that eign credits over a substantial period, and the capital adequacy and asset strength are only two of provision of new money as part of an appropriate several important tests of the strength of a banking adjustment program under IMF auspices, may be organization. Maintaining an adequate liquidity indispensable parts of a favorable resolution of the cushion and opportunities for maintaining and im international debt problem over time. proving earnings without undue risk are also of But clearly the need remains to anticipate new critical importance. problems, as well as to deal with old ones. Recent credit-financed mergers have attracted a great deal The Economic Challenge of attention, and some of those have involved very large and strong companies. But there is a disturb Indicators of overall economic performance have ing element in some mergers and in leveraged buy been exceptionally favorable for more than a year. out activity viewed more generally; it reduces ap So far, a strong economic expansion has been con preciably the equity cushions of the resulting com sistent with better price performance than we have pany. enjoyed for many years. For the economy as a whole, equity in U.S. cor At the same time, there arc obvious strains, im porations ( apart from retained earnings) was retired balances, and risks that, unless dealt with forcefully, at an annual rate of some $75 billion over the first could undercut much ,,f what has been achieved. half of 1984. That seems anomalous at a time of High interest rates are plainly a symptom of the rising business activity and profits, and when excessive demands on our savings as well as linger stronger corporate balance sheet ratios would be ing (and related) concerns about inflation. Cer welcome. In evaluating prospective loans to support tainly, there is no evidence, in the midst of rapid mergers or leveraged buy-outs, bank managers economic expansion, high rates of growth in debt, need to appraise the risks prudently, taking full ac and the monetary trends I have described, that the count of the possibility of a more adverse economic economy has been starved for money and credit. and interest rate environment. That, of course, is Indeed, the challenge over time will remain to work and should be customary policy of banks, and I toward growth of money and credit consistent with sense some have reviewed practices in that respect lasting price stability. And we need to do that in to make sure they arc appropriate in today's cir ways that relieve heavy pressures on vulnerable sec cumstances. tors of the economy, make us less dependent on Asset growth in any event needs to be supported foreign capital, and reduce strains on the interna by adequate risk capital, and I am glad to report tional financial system. that capital positions of the largest banks and their None of these problems will be cured by at holding companies have generally improved over tempts to drive interest rates down artificially by the past few years from the relatively low levels excessive money creation; the inflationary repercus reached during the 1970s. The supe~isory agencies sions could only aggravate the situation. Nor can are in the process of developing guidelines for fur distortions arising from other sources be dealt with ther improvement for those banks and holding effectively by any general monetary measures. companies, and specific proposals are now being tested against public comment. The approaches we are adopting are, I believe, folly consistent with the intent of the International Lending Supervision Act 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis But we are, as a country, by no means helpless And, of course, the challenge remains to reach in dealing with the strains and risks. appropriate judgments on growth in money and With respect to the budget deficits, as things now credit, with the objective of encouraging sustainable stand, deficits next year will remain in the same growth at more stable prices. I have spoken of our area as currently, and unacceptably large thereafter. plans, and I am prepared to address your questions The implications for financial markets and the on that matter today. economy become more adverse precisely as growth But I first want to emphasize the success of all in the private sector generates more need for credit those approaches-and they plainly are within our and capital. That outlook must be changed in the capacity as a nation-are dependent on each other. only way it constructively can be-moving beyond No monetary policy can work without strains in the the welcome "down payment" to further substan face of deficits that preempt so much of our savings tive action on the budget as soon as feasible. as the economy is more fully employed-and, of With respect to our exceedingly large trade defi course, efforts in fiscal and trade policy must pre cit, protectionist pressures are understandable, but sume a prudent monetary policy consistent with it is no less important to avoid measures-all too stability and growth. likely to be emulated abroad-that would drive up In the areas of our responsibility-both monetary costs, undermine the fabric of trade, and place new and supervisory policy-we are working toward barriers in the place of heavily burdened debtors al that end. We count on progress in other directions ready struggling to make necessary adjustments. as well. The facts with respect to growth and infla And industry and labor must continue to be sensi tion for more than a year demonstrate that we all tive to the need to remain competitive in their own have much upon which to build. But there are also wage and price decisions. clear signals that-far from basking in the warmth With respect to our financial fabric, public policy of past and present progress-the strongest kind of needs, at one and the same time, to respond effort will be necessary to convert potential success strongly to threats as they emerge, while undertak into sustained growth and stability. ing supervisory approaches, such as encouraging banks to increase capital, to strengthen that fabric over time. A copy of the full report to Congress is available free of charge from Publications Services, Federal Reserve Board, Washington, D.C. 20551. 8 FRB6-55000-0784 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1984, July 24). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19840725

@misc{wtfs_monetary_policy_report_19840725,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1984},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19840725},
  note = {Retrieved via When the Fed Speaks corpus}
}