Monetary Policy Report

netary Policy s q RC ,. 0b.e ctives for 1985 3 Fede::';~ L I 2 19BS I Midyear Review of the Federal Reserve Board July 17, 1985 Monetary Policy 1985 Objectives for With Tentative Monetary Growth Ranges for 1986 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. July 17, 1985 Contents Section Page Monetary Policy in 1985 and 1986 2 Growth Ranges for 1985 and 1986 2 Economic Projections 3 Review of Economic and Financial Background 5 Monetary Policy • Ill 1985 and 1986 The fundamental objective of the Federal Reserve in Growth Ranges for 1985 and 1986 charting a course for monetary and debt expansion In reexamining its M 1 range for 1985, and in set remains unchanged-to foster a financial environ ting a tentative range for 1986, the FOMC expected ment conducive to sustained growth ·of the economy, that velocity (the rate of nominal GNP to money), consistent with progress over time toward price after its sharp decline in the first half of the year, stability. In working toward those goals, develop would cease falling rapidly-while recognizing that ments with respect to the dollar and our external much of the recent decline may not be reversed. position have necessarily assumed greater promi Allowance also needed to be made for the high nence. More generally, while policy initiatives are degree of uncertainty surrounding the behavior of stated in terms of growth rates of certain monetary M 1 velocity, given the experience of the past few and credit aggregates, the Federal Open Market years. To take account of these considerations, the Committee has emphasized the need to interpret base for the range of M 1 was shifted forward to the those aggregates in the light of other information second quarter of 1985 and the range was set to about the economy, prices, and financial markets. encompass growth at a 3 to 8 percent annual rate Moreover, the monetary targets for 1985 needed to over the second half of this year. This range con be evaluated, and in the case of Ml adjusted, in templates a substantial slowing in growth from the light of the unusual and unexpected behavior of pace of the first half, and the lower part of the GNP relative to money during the first half of this range implies a willingness to see relatively slow year. growth should the recent velocity decline be reversed Growth ranges for 1985 and 1986 selected by the and economic growth be satisfactory. FOMC at its July meeting are shown in the table The appropriateness of the new range will con below. tinue to be reexamined in light of evidence with respect to economic and financial developments, including conditions in foreign exchange markets. It was noted that, because of the burst of money growth in June, the current level of Ml is high relative to the new range. The Committee expected that the aggregate would move into the new range . gradually over time as more usual behavior of velocity emerged. Ranges of Monetary Growth 1985 and 19861 19852 19852 1986 Tentative 2 1985 Actual Ranges set in February Ranges set in July QIV 1984 to QII 1985 3 Percent Percent Percent Percent Ml 4 to 7 3 to 8* 4 to 7 10.5 M2 6 to 9 6 to 9 6 to 9 8.8 M3 6 to 9½ 6 to 9½ 6 to 9 7.9 Total Domestic Nonfinancial Sector Debt 9 to 12 9 to 12 8 to 11 12.84 • Annual rate of growth from the second quarter to fourth quarter 1985. 2 The Committee recognized that uncertainties Economic Projections about interest rates and other factors that could All the monetary ranges specified were felt to be affect velocity would require careful reappraisal at consistent with somewhat more rapid economic the beginning of the year of the M 1 range for 1986 growth than characterized the first half of the year, of 4 to 7 percent. In addition, it was noted that as long as inflationary pressures remain contained. actual experience with institutional and depositor At the same time, Committee members felt that the behavior after the completion of deposit rate deregu present circumstances in the economy contain partic lation early next year would need to be taken into ular risks and uncertainties that can imperil progress account in judging the appropriateness of the over the next year and a half toward either growth ranges. At the beginning of next year, regulatory or price stability. Clearly, the serious imbalances in minimum balance requirements on "Super-NOW" the economy cannot be remedied through the actions accounts and money market deposit accounts will be of the central bank alone. Attainment of fully satis removed, and at the end of March 1986, deposit factory economic performa11:ce and minimization of ceiling rates will be lifted entirely, affecting savings risks will require timely action in other areas of deposits and regular NOW accounts. policy, here and abroad. The economic projections For 1985, with respect to the broader monetary of the members of the FOMC (as well as of the and credit aggregates, the Committee reaffirmed the Reserve Bank presidents who are not at present ranges selected in February. It is recognized, as at members) are shown in the table on the next page. the start of the year, that actual growth over the The projections for a pick-up in GNP growth over four quarters of 1985 might tend toward the upper the reduced rate of the first half of this year are parts of the ranges, and it was felt that this would based in part on the expectation that the declines in be acceptable, depending on developments in the interest rates ( and concomitant rise in stock prices) velocities of the various measures, as long as infla that have occurred over the past few quarters will be tionary pressures remained subdued. providing impetus to demand for goods and services For 1986, the tentative range for M2 was left in the months ahead. Consumer attitudes toward unchanged. The tentative ranges for M3 and total spending appear favorable, and housing activity debt embody reductions from 1985. In the case of already has shown improvement, although FOMC the monitoring range for debt, it was assumed that, members are somewhat concerned about the rising while debt might well continue its tendency of recent debt burdens of households and the increasing pay years to grow considerably faster than GNP,. its ment problems suggested by consumer and mortgage expansion would be tempered by a drop-off in the loan delinquencies. net redemption of equity shares that has boosted In the business sector, inventory overhangs appear corporate credit use dramatically in the past year or to be limited in scope and degree, and fixed invest two. ment seems to have picked up a little after exhibit ing some weakness earlier this year; the lower cost of capital and desires to cut costs and maintain com petitiveness are expected to keep investment on a moderate uptrend, even though pressures on capacity may not be great. Spending by the federal govern ment and by states and localities is expected to grow rather slowly. 3 A key ingredient in many of the projections is the The FOMC members and other presidents also expectation that there will be a tendency in the com assumed that the Congress and the Administration ing year for our external position to stabilize, so that would achieve deficit reductions in the range of domestic production will more fully reflect the those in the recent House and Senate budget resolu expansion of domestic demand. Developments in tions. Failure to move forward with those proposals this area will, of course, depend in part on the would mean a serious risk of reversing the favorable course of economic expansion abroad. Were the effects that congressional actions to date have had on U.S. external position to continue to deteriorate as investor expectations and would create a real impedi it has, the sectoral imbalances in the economy would ment to the solution of the structural problems be exacerbated, creating further difficulties for many plaguing our economy today. companies, their employees and communities. The draining off of income would jeopardize the sus tainability of economic expansion, and the risks of economic and financial dislocations would intensify. Economic Projections for 1985 and 1986 FOMC members and other FRB Presidents5 1985 Range Central Tendency Nominal GNP 6¼ to 7¾ 6½ to 7 Change, fourth quarter to fourth Real GNP 2¼ to 3¼ 2¾ to 3 quarter: Implicit deflator for GNP 3½ to 4¼ 3¾ to 4 Average level in Unemployment Rate 6¾ to 7 ¼ 7 to 7¼ the fourth quarter: 1986 Range Central Tendency Nominal GNP 5 ½ to 8½ 7 to 7 ½ Change, fourth quarter to fourth Real GNP 2 to 4 2 ½ to 3 ¼ quarter: Implicit deflator ~or GNP 3 to 5 ½ 3¾ to 4¾ Average level in Unemployment rate 6¾ to 7 ½ 6¾ to 7 ¼ the fourth quarter: 4 Change from end of previous period, Review of Economic and Financial Background Consumer Price Index • annual rate, percent Economic activity continued to expand during the first half of 1985, but at a relatively slow pace. Real gross national product increased at an annual rate of 15 about 1 percent, falling short of the expectations~o f many forecasters and of the rate anticipated for the year by members of the Federal Open Market Com mittee when they formulated their annual monetary 10 policy plans in February. While the economic envir onment was conducive to the containment of infla tion within the 3 ½ to 4 percent range of the pa~t few years, there has been no further progress to~ard HP 5 full employment of the nation's labor resources or I i I industrial capacity. Indeed, the unemployment rate has remained at about 7 ¼ percent, well below the peak of the 1981-82 recession, but still an histori 1979 1981 1983 1985 cally high level. remained in the neighborhood of $200 billion, rather Change from end of previous period, Real GNP annual rate, percent than moving in the direction of balance as might normally be expected in the course of an upswing in economic activity. The heavy demands pfaced on the credit markets by the Treasury's financing activities 8 have, in turn, been one factor helping to hold real interest rates at historically high levels. And those high rates have contributed to the strong demand of 4 I international investors for dollar-denominated assets and thus to the strength of the dollar on foreign exchange markets. + Hl H2 QI Q2 1979 1981 1983 1985 The slowing of output growth, which began in the middle of 1984, has brought into sharper focus the unevenness of this business expansion and the significance of some basic structural imbalances in the economy. 'rhe federal budget deficit has 5 Exchange Value of the felt with particular severity in the manufacturing, U.S. Dollar mining, and agricultural sectors of the economy, Index, March 1973 = 100 where profitability was squeezed overall and employ ment declined. The lagging growth of production, relatively well 150 contained inflationary pressures on resources, and the high value of the dollar on exchange markets provided the backdrop for the conduct of monetary 125 policy in the past several months. Reserves available to the banking system expanded substantially over 100 the first half of the year, and the discount rate was cut by 1/2 percent in the spring. With the economic expansion slowing, interest rates-which had declined sharply from the summer of 1984 to early 1985- 1979 1981 1983 1985 dropped somewhat further on balance by mid-year. Although the dollar was little changed on balance over the first half, with a spike in its value early in U.S. Current Account Billions of dollars the year being subsequently reversed, the adverse effects on the U.S. trade position of the appreciation of the preceding several years, together with slow ~ 1 + ---------L------"="'----,=--r-:m;:;:;w---~:::,:;sI-- ~r-- ~~~~~:n~r;,~s a~~~~~~;;~~~::~:~~~ ~ i:o:_i- .. 40 petitive pressures, and our exports fell while our imports rose. The widening current account deficit 80 was mirrored in the continuing gap between the i growth of domestic spending and domestic produc tion. Moreover, the effects of this imbalance were 120 Ql 1979 1981 1983 1985 U.S. Real Merchandise Trade Billions of 1972 dollars Imports 120 100 80 Exports 1979 1981 1983 1985 6 The declines in market interest rate in the latter M2 Billions of dollars part of last year and this year had substantial effects, lasting for a number of months, on the 9 demands for assets contained in M 1. Some savings % 2550 apparently were shifted into interest-earning check Annual Rates of Growth 1984 Q4 to 1985 Q2 ing accounts (NOW accounts) from other instru 8.8 Percent 2500 ments, and demand deposits also rose, as the cost of 1984 Q4 to June 1985 6% holding these accounts in terms of earnings forgone 9.3 Percent was reduced. As a result of the shifts of funds, Ml 2450 expanded at a rate well above the 4 to 7 percent rate established in February. At the same time, 24-00 however, the broader monetary aggregates remained ----~---~.L--..,.,,.C..-----"---------- - within their designated ranges. 2350 Mt Billions of dollars 1985 7% 590 The rapid growth of M 1 in the first half of the Annual Rates of Growth 1984 Q4 to 1985 Q2 year was accompanied by a sharp drop in the 10.5 Percent 580 velocity of the aggregate: Ml velocity-the rate of 1984 Q4 to June 1985 4% nominal GNP to money-declined at about a 5 per 11.6 Percent cent annual rate. The recent developments affecting 570 M 1 illustrate the still considerable uncertainties about the shorter-run behavior and trend of its 560 velocity. 550 I I 1984 1985 7 M3 Footnotes Billions of dollars 1. M1 is currency held by the public, plus travelers' checks, plus demand deposits, plus other checkable deposits (including 9.5% negotiable order of withdrawal (NOW and Super NOW) 3200 accounts, automatic transfer service (ATS) accounts, and credit 1984 Q4 to 1985 Q2 union share draft accounts.) . 7. 9 Percent 6% M2 is Ml plus savings and small denomination time deposits, 1984 Q4 to June 1985 3100 plus Money Market Deposit Accounts, plus shares in money 8.2 Percent market mutual funds ( other than those restricted to institutional investors), plus overnight repurchase agreements and certain 3000 overnight Eurodollar deposits. M3 is M2 plus large time deposits, plus large denomination term repurchase agreements, plus shares in money market 2900 mutual funds restricted to institutional investors and certain term Eurodollar deposits. Total Domestic Nonfinancial Sector Debt is outstanding debt of domestic governmental units (federal, state and local), 1 1 1984 1985 households, and nonfinancial businesses. 2. Except for the M 1 range for 1985 set in July, growth ranges are measured from fourth quarter to fourth quarter. 3. Measured from fourth quarter 1984 to June 1985, actual figures are: Ml. 11.6 percent; M2, 9.3 percent; M3, 8.2 per Domestic N onfinancial cent; debt, 12. 7 percent (estimated). Sector Debt 4. Estimated. Billions of dollars 5. Administration budget documents were not available at publication. 12% 6500 Annual Rates of Growth ( estimated) 1984 Q4 to 1985 Q2 9% 12.8 Percent 6300 1984 Q4 to June 1985 12. 7 Percent 6100 5900 1 1 1984 1985 A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 8 FRB 8-52000-0785

Federal Reserve (1985, July 16). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19850717

@misc{wtfs_monetary_policy_report_19850717,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1985},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19850717},
  note = {Retrieved via When the Fed Speaks corpus}
}