Monetary Policy Report

Monetary Policy cti ves for 1985 r----1r--#-I-I--I-L-... nk or ~t. Louis K 5 1 Summary Report of the Federal Reserve Board 't ' ' / tit l •. .l '"" February 20, 1985 Monetary Policy Objectives for 1985 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. February 20, 1985. Contents Section Page The Outlook for the Economy in 1985 2 Prospects and Problems 2 Economic Projections 3 Monetary Policy in 1985 M1 Growth 4 Growth of the Broader Aggregates 5 Monetary Policy and the Performance of the Economy in 1984 6 The Growth of Money and Credit in 1984 6 Economic Performance in 1984 7 The Outlook for the Economy in 1985 Prospects and Problems remain evident among financial institutions: a num ber of depository institutions have experienced a Nineteen eighty-four was another year of substantial deterioration of the quality of their loan portfolios economic growth in the United States. Production and the earnings of thrift institutions remain con and employment gains were large, making the strained by low-yielding assets accumulated in expansion of the past two years-with growth in real earlier years. gross national product averaging 6 percent per While it has not been an impediment to economic year-the strongest cyclical upswing since the early expansion to date, growth in credit has been excep 1950s. Moreover, continued vigor of the economy tionally rapid and many households and businesses was accompanied by signs of some further lowering have accumulated substantial indebtedness often in of inflationary expectations. Aggregate price meas short-term or variable-rate forms that mak~ them ures rose around 4 percent last year, about the same especially vulnerable to unexpected economic as during the two preceding years. While prices of developments. Also, despite the impetus from strong services continued to rise by 5 to 6 percent, prices of U.S. demand, growth in economic activity has been many goods were relatively flat, and underlying limited in a number of important industrialized wage trends seemed to be moderating. countries, and many developing countries, in Latin Economic growth had been extraordinarily rapid America and elsewhere, are still struggling to restore in the first half of 1984, and then slowed abruptly satisfactory growth. While progress was made in around midyear. Although some slowing in growth stabilizing the external finances of some of the was widely anticipated, the abruptness of the change largest of those countries, that progress can only be raised so~e question about the continuing strength secure in the context of greater stability in their own of expansionary forces. However, during the last few economies and of sustained growth in the industrial months of the year, output and employment were ized world. clearly rising, though at a more moderate pace than It is also evident that the enormous imbalances in earlier in the year. our federal fiscal posture and in our trade and cur The strong gains in overall activity during the rent account position have aggravated certain prob year drew attention away from a number of continu lems and made constructive solutions much more ing problems, but those problems were nonetheless difficult. In an expanding economy requiring more real and serious. The overall rate of unemployment private credit, the need for credit to finance the is still uncomfortably high and the joblessness large federal deficits has contributed to the pressures among certain groups-for ·example, teenagers and that have held real interest rates at historically high blacks-remains well above the average. Sectors of levels. The failure to deal with budgetary deficits the economy facing intense competition from also has sustained doubts in the minds of the public abroad, such as agriculture and certain mining and about the ability of the government to continue to manufacturing industries, have not participated in curb inflation over the long run. the rapid economic expansion overall, and have The large federal deficits are mirrored in our been under strong financial stress. Strains also external imbalance. Many foreign investors have been attracted to the comparatively high real rates of return offered on dollar-denominated assets, and U.S. lending abroad has been reduced. Other forces stimulating capital inflows have been at work, including political and economic uncertainties in other countries and the relative stability and vigor of our economy. The shift in capital flows has supple mented domestic saving and helped finance the fed eral government deficit and private investment. But, at the same time, the strong demand for the dollar has driven its value on foreign exchange markets to 2 extremely high levels. As the dollar has appreciated, well along in the process of correction, and in some the demand for our exports has suffered and our sectors inventories are quite lean relative to sales. purchases of imported goods have increased dramati Many states and localities are experiencing an cally, resulting in strong pressures on the manufac improvement in their finances, which portends fur turing, mining, and agricultural sectors and leading ther support to the expansion from that sector, and to calls for protectionist measures. Moreover, the at the Federal level, there continues to be a strong capital inflows lead to mounting financial claims of stimulative thrust from fiscal policy. foreigners that the nation must be prepared to deal The smallest increases in nominal wages and com with in future years through reduced imports or pensation in more than a decade have been accom increased exports, in either case lowering domestic panied by an improvement in productivity and consumption. downward pressures on energy and commodity prices. These developments help support the possi bilities of continuing restraint in price increases. Economic Projections Also, in the context of an economy expanding at a Notwithstanding the risks associated with these sustainable rate, they are consistent with continuing j omestic and international problems, the weight of growth in average real income. the evidence points to reasonably favorable near Taking account of these factors, the members of term prospects for aggregate economic performance. the Federal Open Market Committee (as well as In recent months, personal income growth has been Federal Reserve Bank Presidents who are not at strong, reflecting continuing substantial gains in present FOMC members) foresee the probable con employment, and helping to support consumer tinuation of the economic expansion through its spending. Overbuilding of multifamily residential third year, although at a more moderate pace than units and offices in some parts of the country may in the first two years. In their forecasts, the Com pose questions about the outlook in these areas, but mittee members assumed that the exchange rate the lower interest rates that developed over recent would remain within the range of recent months and months suggest that single-family homebuilding may that effective fiscal action is in prospect. strengthen. Surveys of businesses indicate plans for continued growth in plant and equipment spending in the coming months, though at a slower pace than last year. Meanwhile, some imbalances in business inventories that developed during 1984 appear to be Economic Projections for 1985 (percent) FOMC members and other FRB Presidents Administration CBO Range Central Tendency Nominal GNP 7 to 8½ 7½ to 8 8.5 7.7 Change, fourth quarter to fourth Real GNP 3¼ to 4¼ 3½ to 4 4.0 3.4 quarter: Implicit deflator for GNP 3 to 4¾ 3½ to 4 4.3 4.2 Average level in Unemployment Rate 6½ to 7 ¼ 6¾ to 7 6.9 7.0 the fourth quarter: 3 Monetary Policy • 1985 Ill At its February meeting, the FOMC set monetary 1984 was broadly consistent with previous cyclical and credit growth ranges for 1985 designed to be pattens. Together with other evidence, this develop consistent with further sustainable economic growth ment suggests that the factors responsible for the and progress toward reasonable price stability over unusually high velocity behavior over 1982 and early time. The growth ranges for the monetary and 1983 have receded. credit aggregates for 1985 are shown below. Nonetheless, a range of uncertainty inevitably The upper end of the range for Ml is one per remains about the trend of M 1 relative to nominal centage point below that of 1984, and the range for GNP in light of recent deposit deregulation and M2 is the same as last year's. The upper end of the other financial innovations that have affected the target range for M3 is slightly above that for last funding policies of banks and the cash management year. That increase, as well as the upward adjust practices of the public. On balance, it appears likely ment in the associated monitoring range for the debt that the process of deposit deregulation will lead to a of domestic nonfinancial sectors, reflects analysis of trend rate of increase in the velocity of M 1 that may developments during 1984 suggesting that growth be somewhat lower than in the post-World War II somewhat greater than anticipated earlier may be period as a whole. However, in view of the multi consistent with Committee objectives for the year. plicity of changes in financial instruments and prac Expansion within these ranges would represent a sig tices that influence the behavior of all the monetary nificant deceleration in the actual growth of M3 and measures, interpretation of all the aggregates will debt from the experience of last year when the tar continue to be made within the context of the out get ranges were exceeded. look for economic activity, inflationary pressures, In formulating these objectives, the Committee and conditions in domestic and international finan assumed that no new statutory or regulatory cial markets, including the strength of credit developments would be enacted that would appre demands. ciably influence the behavior of the monetary and credit aggregates in 1985. M1 Growth On average, the behavior of Ml velocity norn~nal GNP divided by the money stock-during The new target range for Ml encompasses growth in Ml consistent with velocity expansion over the corning year approximating that of last year, and also higher M 1 growth that would be needed should Ranges of Monetary Growth 1985 1 velocity grow at a rate approximating the reduced trend suggested above. The movements in velocity Measured from fourth quarter 1984 to fourth quarter 1985 during 1984 occurred in a context of moderate M1 4 to 7 percent increases in interest rates over much of the year; how~ver, velocity has slowed substantially in recent M2 6 to 9 percent months in the context of an appreciable rise in money growth and following declines in interest M3 6 to 9 ½ percent rates. In all the circumstances, a somewhat higher Total Domestic rate of money growth than implied by straight line Nonfinancial Debt 9 to 12 percent projections from the fourth quarter 1984 base to the targets for the fourth quarter of 1985 may be appropriate early in the year, but growth of M 1 would be expected to slow, and velocity growth to rise, as the current adjustments are completed. Thus, as the year progresses, growth of Ml would be expected to move gradually toward and into the FOMC's target range. Depending upon develop- 4 men ts with respect to velocity and price behavior, rapidly than nominal GNP. Still, actual growth of growth in M 1 and the other monetary aggregates in debt in 1985 should be markedly less than in 1984, the upper parts of their ranges may be appropriate as nominal GNP growth and overall credit demands over the year as a whole. Those developments will, moderate. Growth within the debt range for 1985 of course, be closely monitored over t~e year. assumes also a slowing in credit for mergers, lever aged buyouts, and other financial restructuring. Such credit led to some erosion in corporate equity Growth of the Broader Aggregates cushions last year, and a more cautious approach is Like Ml, growth of M2 and M3 has been particu anticipated this year. larly strong in recent months, reflecting the The outlook for financial conditions generally is unusually favorable yield spreads in favor of mone again expected to be affected importantly by current tary assets that emerged temporarily toward the end and prospective federal budget deficits, which will of last year. In addition, M3 growth has reflected remain enormous in comparison with experience in substantial issuance of large CDs by thrift institu previous economic expansions. This massive federal tions to support their lending in mortgage and con borrowing will compete for available domestic sav sumer loan markets. ings with the strong private credit demands accom Grpwth of the broader monetary aggregates is panying further growth of economic activity, keep influenced, as well, by the pattern of international ing interest rates and exchange rates higher than capital inflows associated with the huge current they otherwise would be. Such relatively high account deficit. By reducing the need for funding interest rates and exchange rates limit expansion in through other managed liabilities included in M2 those sectors that are most sensitive to the cost of and M3, these inflows tend to restrain measured credit and impair the competitive positions of monetary growth in relation to growth of bank domestic import-competing and export industries. credit and credit generally. Moreover, many domes Decisive and credible actions to reduce federal tic borrowers, including the federal government and budget deficits would have favorable effects on private corporations, may continue to tap overseas investors' expectations and help to lower interest securities markets directly, reducing the need for rates, especially longer-term rates, even before these credit expansion by U.S. intermediaries. reductions become fully effective. Such actions Given the federal budget deficit as projected by would work to relieve the imbalances and strains the Administration for 1985-as well as an expan within the economy, contribute to further abatement sion of spending by domestic sectors in excess of of inflationary expectations, and so reinforce the nominal GNP growth, as part of that spending flows prospects for continued growth and stability. abroad-the Committee contemplates that domestic nonfinancial debt may continue to increase more Growth of Aggregates 19842 1984 Range 1984 Actual 1984 Q4 Levels* Ml 4 to 8 percent 5.2 percent 553.7 M2 6 to 9 percent 7. 7 percent 2345.4 M3 6 to 9 percent 10.5 percent 2960.6 Total Domestic Nonfinancial Debt 8 to 11 percent 13. 4 percent 5869.7 *Billions of dollars seasonally adjusted 5 Monetary Policy and the Performance of the Economy in 1984 The Growth of Money and Credit in 1984 M2 -Billions of dollars Monetary policy in 1984 aimed basically at supporting --- Range adopted by FOMC for sustainable economic growth within the context of 1983 Q4 to 1984 Q4 long-term progress toward price stability. 2400 Underlying these objectives was the Committee's Rate of Growth expectation that the special factors distorting monetary 1983 Q4 to 1984 Q4 growth rates in 1982 and 1983 would be less important in 1984, and that relationships among the monetary 7. 7 Percent aggregates-particularly Ml-and economic activity and inflation would be more consistent with historical trends and cyclical patterns. Portfolio adjustments associated with the previous introduction of new deposit accounts and with the steep drop in interest 2250 rates during the 1982 recession appeared to have ended. Furthermore, the economic expansion seemed to be reducing uncertainties about employment and 2200 income prospects that earlier had boosted demands for liquid precautionary balances. Over the year, increasing evidence suggested that 0 N D J F M A M J J A S O N D Ml was in fact behaving more in line with historical 1983 1984 Mt Billions of dollars experience. As a result, this aggregate was given more weight in policy implementation than had been the --- Range adopted by FOMC for case during the latter part of the cylical downswing 1983 Q4 to 1984 Q4 and early phase of the economic recovery. However, all of the monetary and credit measures continued to be 8% ~o evaluated in light of the outlook for the economy and domestic and international financial markets. Rate of Growth 1983 Q4 to 1984 Q4 The actual growth rates of Ml and M2 over 1984 were well within the target ranges established by the 5.2 Percent Federal Reserve. As had been anticipated in the mid year policy report to the Congress, growth of M3 and / -- domestic nonfinancial debt exceeded their ranges. The / / - - -- 4% relatively wide divergence between M2 and M3 --/-/- growth rates reflected mainly substantial issuance of -/ large CDs and other managed liabilities by thrift insti / // 530 tutions and commercial banks in the face of heavy credit demands. Credit growth last year was the most rapid on rec ord, and much stronger relative to GNP expansion than historical trends would suggest. An unusually 0 N D J F M A M J J A S O N D large volume of mergers and related activity, including "leveraged buyouts;' involving nonfinancial corpora- 1983 1984 6 tions, accounted for about 1 percentage point of the M3 Billions of dollars growth of overall debt. Around $75 billion of ~quity was liquidated in this process, with much of it --- Range adopted by FOMC for replaced, at least for a ti~e, with short-term debt. 1983 Q4 to 1984 Q4 Even after allowance is made for the unusually large 3000 volume of merger-related borrowing, it is clear that Rate of Growth total credit demands were exceptionally strong last 1983 Q4 to 1984 Q4 year. Federal debt expansion, at more than 16 percent, 10.5 Percent 2900 was unprecedented for the second year of an economic expansion, both in absolute terms and in relation to 6% income. Private domestic nonfinancial debt grew about 11 ½ percent ( abstracting from growth of merger -- 2800 related debt issues), also faster than, but much closer to, comparable stages of previous recoveries. 2700 Economic Performance in 1984 The economy recorded major gains in 1984, with the real gross national product up 5 ½ percent and the 0 N D J F M A M J J A S O N D unemployment rate down more than 1 percentage 1983 1984 Growth of Money and Credit (Percentage changes)3 Domestic Period M1 M2 M3 N onfinancial Debt Fourth quarter to 1979 7.5 8.1 10.3 12.1 fourth quarter 1980 7.5 9.0 9.6 9.6 1981 5.1 (2.5)4 9.3 12.4 10.0 1982 8.8 9.1 10.0 9.1 1983 10.4 12.2 10.0 10.8 1984 5.2 7.7 10.5 13.4 Quarterly Q1 6.2 7.2 9.2 12.9 growth rates 1984 Q2 6.5 7.1 10.5 13.1 Q3 4.5 6.9 9.5 12. 7 Q4 3.4 9.0 11.0 12. 7 7 point over the year. The growth in output and Real GNP Percent change, Q4 to Q4 employment was exceptionally strong in comparison with experience in other post-Korean War expansions. But even more striking, in terms of its departure from 8 past norms, was the extraordinary rise in domestic spending, which again appreciably outstripped growth in domestic production. Over the course of the year such spending rose 6¾ percent in real terms. Con sumers and businesses purchased greatly increased quantities of imported goods, whose relative prices were lowered by the appreciation of the dollar in exchange markets, and the U.S. trade deficit reached record proportions. Last year's economic gains were achieved without a 1979 1980 1981 1982 1983 1984 pickup in inflationary pressures, in part owing to the rise in the exchange value of the dollar. Aggregate indexes of prices rose about 4 percent or less, similar to rates of inflation recorded in 1983. Ample availabil tom of continuing imbalances has been interest rates ity of industrial capacity here and abroad helped to that, relative to the prevailing rate of inflation, have contain price increases. Labor cost pressures also were remained exceptionally high by historical standards. limited, as wage increases actually were slightly lower However, after moving upward during the first half of than a year earlier. Labor markets continued to reflect the year when economic expansion was especially the still considerable unemployment in the economy as brisk, interest rates retraced their advances in the sec well as the adjustments of wages in some sectors to the ond half of the year. At year-end, they were, on bal realities of forces associated with deregulation and for ance, a little lower. eign competition. Wage changes also reflected the Federal government tax and spending policies have favorable feedback effect of lower inflation on anticipa provided substantial stimulus to aggregate demands for tory or catch-up pay demands. goods and services, but in credit markets the deficits Although the nation as a whole has made great have added strongly to the demands for funds and progress in the past two years toward the goals of sus have been one important force keeping interest rates tained growth and high employment along with price high. Moreover, there is general agreement that unless stability, many segments of the economy have con legislative measures are enacted, budget deficits are tinued to experience considerable difficulty. One symp- likely to increase further, even in the context of a reasonably growing economy. This prospect, with its implication of continuing pressures on the supply of savings, has been a factor in the rise in the foreign exchange value of the dollar and the attendant emer gence of enormous deficits in our trade and current accounts with other nations. Although the sharply higher value of the dollar has been an important fac- 8 tor in the movement toward price stability, inflationary Federal Government Deficit Billions of dollars pressures could become more apparent if the U.S. dol- lar were to decline sharply-a risk that could increase Fiscal Years, Unified Budget Basis as fundamentally unsustainable fiscal and external postures are extended. Household Sector The household sector continued to benefit last year from the economic expansion. Adjusting for inflation, the rise in disposable income from the fourth quarter of 1983 to the fourth quarter of 1984 was 5¾ percent, surpassing the large gain in 1983. This strong increase in income supported a rapid rise in spending for con sumer goods even as the personal saving rate rose. Growth of household indebtedness picked up notice ably last year, and consumer installment debt as a share of disposable income moved to near its previous peak in the late 1970s. Despite the rise in indebted 1979 1980 1981 1982 1983 1984 ness, there were few signs of increased financial stress in the household sector. The incidence of payment difficulties on consumer installment debt remained prospects in this area owing to the added risk exposure of homeowners who took on mortgages car historically low and home mortgage deliquency rates were about unchanged for the year as a whole. None rying adjustable features, especially those made with theless, the proportion of problem loans in the home sizable initial interest rate concessions. The sustained mortgage market has not receded from its recession high level of mortgage loan delinquencies appears to high, and there is some special concern about future date attributable not so much to adjustable rate loans as to a combination of still high unemployment and more stable real estate prices than some borrowers had anticipated. Percent change, Consumer Prices December to December Business Sector The increase in business spending for plant and equipment was greater in 1984 than in 1983. In 15 fact, the rise in gross business capital outlays over these two years combined was much larger than in any other post-World War II economic expansion. Profits in the nonfinancial corporate sector were up 1979 1980 1981 1982 9 substantially in 1984, although by year-end the level Exchange Value of the had fallen back a bit owing to the slowing in sales U.S. Dollar Index, March 1973 = 100 growth. Continued competitive pressure from foreign producers provided additional impetus for rapid 150 modernization. At the same time, many U.S. pro ducers of capital equipment, especially outside the ''high-tech'' area, did not fully benefit from this spending. Instead, foreign manufacturers captured an increasing share of capital goods purchased by U.S. firms; for domestic spending, this share approximately 25 percent-was nearly twice that experienced in the late 1970s. Severe financial strains, in many cases related to the high exchange value of the dollar, persisted in 1979 1980 1981 1982 1983 1984 some of the nation's basic industries. Farmers con tinued to face less favorable export conditions than in much of the previous decade, land prices fell fur The Foreign Sector ther, on average, and farm income remained The appreciation of the dollar over the last four depressed. As a result, farmers with large volumes years directly contributed to the imbalance between of debt remaining from the late 1970s continue to exports and imports in 1984. On a trade-weighted face serious debt-servicing problems. The metals, average basis, the dollar climbed a further 12 per agricultural implements, and some equipment indus cent during the course of the year, bringing the tries also continue to face significant problems. cumulative appreciation since the end of 1980 to about 65 percent, and the rise has continued in 1985. Part of the dollar's strength in the first half of U.S. Current Account* Billions of dollars last year may have been generated by a widening of the differential between real interest rates in the United States and real rates abroad; however, the influence of this factor appears to have been reversed in the second half of the year. The relative dynamism of the U.S. economy and success in curb ing inflation helped attract capital from abroad. Conversely, relatively slow economic growth else where and economic and political uncertainties in various countries also may have contributed to the dollar's appreciation throughout the year. The cur rent account deficit was about $100 billion in 1984, compared to $42 billion in 1983. 1979 1980 1981 1982 1983 1984 * 1984 is partially estimated. Labor Market Developments Developments in labor markets continued to be favorable during the second year of expansion. Reflecting the strength of activity and improved employment prospects, growth of the labor force 10 picked up last year. But the number of new jobs Footnotes expanded even more rapidly, and the unemployment 1. M1 is currency held by the public, plus travelers' checks, rate was 7. 2 percent in the fourth quarter, more plus demand deposits, plus other checkable deposits (including than a percentage po~nt below the rate at the end of negotiable order of withdrawal (NOW and Super NOW) 1983. Indeed, since the recession low in late 1982, accounts, automatic transfer service (ATS) accounts, and credit nonfarm payroll employment has increased by union share draft accounts). nearly 7 million, the largest two-year gain in three M2 is M1 plus savings and small denomination time deposits, decades. plus Money Market Deposit Accounts, plus shares in money Wage developments in 1984 were more favorable market mutual funds ( other than those restricted to institutional to the control of inflation; even though labor market investors), plus overnight repurchase agreements and certain slack was reduced substantially further during the overnight Eurodollar deposits. M3 is M2 plus large time deposits, plus large denomination year, wage rates increased less than in 1983. The term repurchase agreements, plus shares in money market employment cost index, a comprehensive measure of mutual funds restricted to institutional investors and certain change in wages and benefits, rose just 4 percent in term Eurodollar deposits. 1984, nearly one percentage point less than the year Total Domestic Nonfinaricial Sector Debt is outstanding earlier. Moreover, major collective bargaining agree debt of domestic governmental units (federal, state and local), ments during the year showed no acceleration in households, and nonfinancial businesses. nominal wage rates, even in those industries with 2. Ranges for the aggregates and ''Actual'' figures for 1984 are improved economic conditions. measured from fourth quarter 1983 to fourth quarter 1984. The Over the course of the year, labor productivity figures for the monetary aggregates are based on recent bench increased 2 ¼ percent, partly reflecting a cyclical mark and seasonal adjustment revisions. Before those revisions, adjustment to higher levels of output as well as the 1984 increases were measured at 5.0 percent for M1, 7.5 percent for M2, and 10.0 percent for M3. apparently some improvement in the underlying 3. M1, M2, and M3 incorporate effects of benchmark and sea trend rate of growth from the very low pace of the sonal adjustment revisions. 1970s. 4. M1 figure in parentheses is adjusted for shifts to NOW accounts in 1981. U.S. Merchandise Trade Billions of dollars 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 11 FRB 7-52000-0285

Federal Reserve (1985, February 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19850220

@misc{wtfs_monetary_policy_report_19850220,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1985},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19850220},
  note = {Retrieved via When the Fed Speaks corpus}
}