Monetary Policy Report

etary Policy t\,.;, ~f;~~~-:,,· ~ ·nk 26 l)bjectives for 1987 rm Summary Report of the Federal Reserve Board February 19, 1987 Monetary Policy Objectives for 1987 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. February 19, 1987. Contents Section Page Monetary Policy and the Economic Outlook for 1987 2 Monetary Policy for 1987 3 Economic Projections 4 Economic Performance During the Past Year 5 Price and Wage Developments 6 The External Sector 7 Monetary Policy and Financial Markets in 1986 9 Money, Credit, and Monetary Policy 10 The Household Sector 12 The Business Sector 12 The Thrift Industry 13 Regulatory and Supervisory Functions 13 Monetary Policy and the Economic Outlook for 1987 The current economic expansion in the United States Ranges of Growth for Monetary and has entered its fifth year, ranking it among the long Credit Aggregates 1 est of the postwar period. While substantial imbal ances and risks have emerged in the course of the Percent change, fourth quarter to fourth quarter expansion that must be dealt with forcefully and effectively, important groundwork also has been laid 1986 for continued growth through 1987 and beyond. Sig 1987 Target Actual nificantly, price trends thus far have remained favor able, reflecting not only the dramatic drop in crude M2 5½ to 8½ 6 to 9 8.9 oil prices in early 1986 but also continued restraint M3 5½ to 8½ 6 to 9 8.8 on labor costs in many sectors. Interest rates have moved lower and stock prices Debt 8 to 11 8 to 11 12.9 higher, reducing the cost of capital for investment and enhancing wealth. Furthermore, processes are in train that should help correct the major imbalav.ces that have been plaguing the economy: action has Federal Reserve policy has a critical role to play. been taken to cut the deficit in the federal budget, Monetary expansion, while adequate to support and the foreign exchange value of the dollar has orderly economic growth, needs to be consistent with moved to levels that have made U.S. firms more continuing progress over time in reducing the under competitive in world markets and should help correct lying rate of inflation. As the experience of recent the imbalance in the U.S. external accounts. years has demonstrated, such a policy-in part by While the potential for further economic progress bolstering confidence in financial markets and provid thus appears considerable, those gains will be secured ing a framework of greater certainty for private only if there is timely and constructive action by decisionmaking-can make a substantial contribution decisionmakers in the public and private sectors. to the maintenance of expansion and the reduction of Congress and the Administration must follow up the unemployment. In the short run, a variety of factors steps already taken and make basic programmatic such as interest rate movements, regulatory changes, changes that will ensure continuing movement toward and institutional innovations, among others-may budgetary balance; failure to do so would be damag alter considerably the amount of funds the public ing to confidence and disruptive to the financial mar wishes to hold in monetary form. Over time, how kets. Many of our major trading partners, which ever, expansion of the money stock measures clearly have depended greatly on external surpluses to buoy must moderate from recent rates if destabilizing pres their economies over the past few years, must act to sures are to be avoided. The Federal Open Market open their markets more fully and to foster sustained Committee (FOMC) has established targets for 1987 growth in domestic demand; without such action, with that fact in mind, but it will continue to inter prospects for world growth as well as for reducing pret the movements in the monetary aggregates in our own trade deficit would be impaired, the risks of light of developments in the economy and in domes protectionism would rise, and prospects for the dollar tic and international financial markets and the poten would be more uncertain. And, if we are to capital tial for inflationary pressures. ize on those trading opportunities and promote eco nomic and financial stability at home, labor and management must avoid a return to the inflationary behavior of the past. Oil prices have firmed recently, and the sizable decline in the dollar is likely to exert 1,.1pward pressure on other prices in the months ahead; the challenge is to prevent such developments from triggering a cumulative price-wage spiral. 2 Monetary Policy for 1987 Moreover, only with the passage of time will it become possible to assess with any precision the The FOMC believes that a reduction in the growth longer-term trend in growth of M 1, under current of the money supply measures, over time, will be institutional arrangements, relative to nominal GNP. needed if the economy is to achieve noninflationary Given these circumstances, the appropriateness of growth and external equilibrium. The precise timing different rates of M 1 growth cannot be assessed in and degree of that moderation in monetary expansion isolation; rather, the movement of this aggregate will depend on prevailing circumstances in the U.S. necessarily will be evaluated in the light of expansion economy and in domestic and international financial in M2 and M3, growth of the domestic economy, markets. The Committee has established target ranges for M2 and M3 of 5 ½ to 8 ½ percent from and emerging price pressures, which in turn are partly related to changes in the value of the dollar. the fourth quarter of 1986 to the fourth quarter of The Committee will continue to· monitor the 198 7. The ranges for M2 and M3 are one-half per growth of debt. Growth of domestic nonfinancial centage point below those in effect for 1986, and are sector debt in recent years consistently has exceeded below the actual growth rates last year. Indeed, in an both the Committee's expectations and, more impor environment without the dramatic movements in tant, the expansion of income by a wide margin. interest rates of recent years, only small changes in This is a matter of concern, for it has resulted in the velocity of these aggregates would be anticipated. potential fragilities in the nation's financial structure. The Committee now expects growth of M2 and M3 Although the range for the debt measure has been this year to be in the middle of their ranges. kept at 8 to 11 percent, the same as in 1986, that The FOMC elected not to establish a specific tar range implies a significant slowing from the almost get range for Ml at this time because of uncertainties 13 percent pace last year-but to a rate still in excess about its underlying relationship to the behavior of of that expected for income. With a reduced federal the economy and its sensitivity to a variety of eco deficit, borrowing by the federal government will nomic and financial circumstances. With the deregu slow. Also, new constraints imposed by tax reform lation of deposit rates, and the attendant changes in legislation should reduce the presence of state and the composition of M 1, the narrow money measure local governments in the financial markets. Borrow has become much more responsive in the short run ing by nonfinancial business firms is expected to to changes in interest rates, and possibly to other fac grow at about the same rate as last year. Tax reform tors affecting the portfolio decisions of households. should result in some reduction in the volume of Economic Projections for 1987 (percent) FOMC members and other FRB Presidents Administration Range Central Tendency Nominal GNP 4½ to 7 ½ 5¾ to 6½ 6.9 Change, fourth quarter to fourth Real GNP 2 to 4 2½ to 3 3.2 quarter: Implicit deflator for GNP 2½ to 4 3 to 3½ 3.6 Average level in Unemployment Rate 6½ to 6¾ • 6½ to 6¾ • 6.5 the fourth quarter: *Civilian unemployment rate. 3 equity shares retired in connection with mergers and the dollar, and this should bolster export growth and other corporate restructurings, but such activity-and help curb the expansion in imports. But there still is the attendant borrowing-appears likely to remain considerable uncertainty about some of the other fac significant, in some cases undermining the financial tors affecting the external sector. In particular, the strength of corporations as they become more heavily expansion in exports is contingent on a satisfactory leveraged. Moreover, firms may have a wider gap pace of economic activity abroad over time, on con than last year between internally generated funds and tinued progress in handling international debt prob investment expenditures, owing in part to higher lems, and on enhanced access to foreign markets. On corporate tax bills. Growth of household debt also is the import side, the improvement is predicated on a expected to be about the same as last year. Con substantial rise in the relative price of foreign goods. sumer installment credit clearly is decelerating, but That unfortunately carries with it some domestic growth of mortgage debt should be robust, reflecting inflationary risks, underscoring the need for prudent both a good housing market and the substitution of fiscal and monetary policies. home equity lines of credit for installment borrowing. Slower growth of domestic demand is expected to release resources to the external sector in 1987. Con sumer. spending is projected to rise less rapidly than Economic Projections in 1986, given that the saving rate has fallen to an The Committee believes that its monetary objectives extremely low level and real income gains in 1987 are consistent with continued moderate growth in are likely to be damped by rising energy and non economic activity and a relatively modest upturn in petroleum import prices. inflation in 1987 that would be attributable almost The effect of the dollar depreciation on prices is entirely to higher import prices and a rebound in likely to be felt more strongly in 1987. In addition, energy costs. The central tendency of the forecasts of crude oil prices have rebounded in the past few Committee members and other Reserve Bank Presi months, reversing part of the sharp drop that dents is for growth in real GNP of around 2 ½ to 3 occurred early last year. However, the favorable trend percent. Such an increase in output would be in wages and other costs, combined with sizable expected to generate substantial gains in employment, productivity gains in manufacturing, provides the and the jobless rate is projected to drift down a bit opportunity for absorbing these short-run price over the year. Prices, as measured by the implicit shocks while maintaining a sense of progress toward deflator for GNP, are expected to rise 3 to 3 ½ per greater underlying price stability. The Committee's cent. It should be noted that the rise in energy and projections anticipate that neither significant capacity import prices likely will have a somewhat greater constraints nor strong labor market pressures will effect on consumer prices, so that measures such as develop and that domestic firms will not squander the the Consumer Price Index may rise faster than the opportunity to regain markets in a shortsighted effort GNP deflator-a pattern that emerged in the second to expand profit margins unduly as demand for their half of 1986. products increases. The forecasts of the Committee members and the The central tendency projections of real GNP and other Reserve Bank Presidents assume that Congress inflation are slightly lower than the forecasts of the will make further progress in reducing the federal Administration. However, given the uncertainty of budget deficit. Continuing evidence of fiscal restraint economic forecasting, the differences are not signifi is viewed as crucial in maintaining financial condi cant, and, in fact, t~e Administration projections are tions that are conducive to balanced growth and an well within the full range of expectations among improved pattern of international transactions. Committee members and other Reserve Bank Orderly growth in GNP has become increasingly Presidents. dependent upon a substantial improvement in real net exports. The international competitiveness of U.S. firms clearly has benefited from the decline in 4 Economic Performance During the Past Year In 1986 the economy completed a fourth consecutive Quarterly Civilian Unemployment Rate year of expansion, with real gross national product average, percent increasing a little more than 2 percent. The rise in overall activity was similar to the gains that had 10 been recorded, on balance, since mid-1984 and was sufficient to create 2 ½ million new payroll jobs. The 9 jobless rate for civilians continued to edge down and, at year-end, was 6¾ percent. Inflation slowed sharply with virtually all broad 8 measures of price trends showing their smallest increases in many years. Although the sharpness of 7 the deceleration owed much to specific developments in the markets for oil and other commodities, the favorable inflation performance also represented at a 1982 1984 1986 fundamental level the continuation of trends in wage and price behavior fostered by policies in place since the early part of the decade. farm enterprises faced with sharply lower crop Although output continued to grow in 1986, the prices. In addition, major segments of the indus economy still was characterized by pronounced trial sector continued to struggle with intense for imbalances. These were reflected in marked dispari eign competition, and relatively low rates of ties in economic performance across industries and capacity utilization-along with a glut of office regions of the country. In particular, domestic oil space-depressed capital spending. exploration and investment was cut back sharply, The most serious imbalances continue to be in and only massive federal subsidies sustained many the external sector and in the federal budget developments that are linked. Although the foreign exchange value of the dollar against the other Real GNP Percent change, Q4 to Q4 G-10 currencies has declined roughly 40 percent over the past two years, the nation's trade balance continued to deteriorate in 1986. Real export growth did pick up in response to the enhanced international competitiveness of U.S. firms, although the rebound was damped somewhat by the relatively slow growth of the economies of our major trading partners. However, import volumes continued to expand rapidly through most of the year, in part because much of the swing in 1982 1984 1986 5 Federal Government Deficit Price & Wage Developments Billions of dollars The fixed-weighted price index for GNP rose about Fiscal Years 2 ½ percent in 1986, down from an increase of 3 ½ percent in 1985. The increase was the smallest in more than two decades. Some other popular meas ures of prices decelerated even more markedly. The Consumer Price Index (CPI) for goods and services rose only about 1 percent, and the Producer Price Index (PPI) for finished goods actually fell 2 ½ percent. The greater deceleration in the CPI and PPI than in the GNP price measure is a reflection of the greater importance of energy prices in those indexes. The movements in energy prices over the past year or so have been striking. World crude oil prices dropped from $26 per barrel in late 1985 to the $11 1982 1984 1986 per barrel range around mid-year; these prices trended up over the second half and recently have risen to around $18 per barrel in the wake of the exchange rates apparently was absorbed in the profit agreement on production limits reached at the margins of foreign exporters and U.S. distributors, OPEC meeting in late December. The drop in crude thereby limiting increases in the prices of imported oil prices was reflected fairly rapidly in retail energy goods. As a result, the current account deficit con prices which declined 20 percent last year. The effects tinued to widen, reaching the $150 billion range in of the recent firming in oil prices are already evident 1986. in general indexes: the PPI jumped 0.6 percent in The federal budget deficit also increased, hitting January, owing largely to the rebound in gasoline $221 billion in fiscal 1986. The deficit vastly exceeded and heating oil prices. official targets, as underestimates of program costs Price increases outside the energy area generally and shortfalls in revenues offset the deficit-reducing remained moderate in the past year. Retail food actions taken by the Administration and the Con prices rose 4 percent, a bit more than in 1985, gress. Recent estimates suggest that the deficit for fiscal year 1987 will decline to the $175 billion range, which is a good deal less than the year earlier but Percent change, considerably above the Gramm-Rudman-Hollings Consumer Prices* December to December target of $144 billion. 9 6 I ll'i! ----- 3 1982 1984 1986 *Consumer Price Index for all urban consumers. 6 reflecting the effects of last summer's heat wave in U.S. Current Account Billions of dollars the Southeast. However, prices of retail goods, excluding food and energy, continued to slow and, on balance, were up only 1 ½ percent. The influence + of the depreciating dollar on consumer goods prices was highly variable across sectors and relatively 50 small overall. Prices for many basic industrial commodities con 100 tinued to decline over the first three quarters of 1986. Excess capacity in some basic industries and the generally abundant world supplies of many primary 150 commodities contributed importantly to the weak- ness in these prices. Sluggish industrial activity in the United States and other large economies also 1982 1984 1986 was a factor. Prices in a number of these markets *Estimated. have turned up in recent months, possibly in response to the firming in U.S. industrial activity. N onethe The External Sector less, industrial commodity prices still are well below the most recent peaks reached in mid-1984. Widening U.S. trade and current account deficits Wages continued on a path of moderation in have aroused deep concern because of their implica 1986. Hourly compensation in the nonfarm private tions both for the orderly expansion of the domestic sector, as measured by the employment cost index, economy and for international financial stability. rose about 3 ¼ percent, 3/4 percentage point less The foreign exchange value of the dollar, which had than in 1985. The deceleration in wages reflected declined about 20 percent against a weighted-average the continued slack in labor markets as well as the of the currencies of other G-10 countries from Feb reduction in price inflation, and was widespread ruary 1985 to December 1985, has fallen an addi across industries and occupations. tional 20 percent since that time. Because the U.S. inflation rate over the past two years was approxi mately the same as the average inflation rate in Exchange Value of the other G-10 countries, the decline in the real value of U.S. Dollar* Index, March 1973 = 100 the dollar (that is, adjusted for relative inflation rates) was similar to the nominal decline. 1981 1983 1985 *Federal Reserve index of weighted average exchange value of U.S. dollar against currencies of other G-10 countries plus Switzerland. Weights are 1972-76 global trade of each of the 10 countries. 7 As measured by broader exchange-rate indexes, U.S. Real Merchandise Trade Billions of 1982 dollars which include the currencies of major developing countries as well, the real decline in the value of the dollar was somewhat smaller. This was due in part because some of those countries allowed their cur rencies to depreciate as part of an effort to improve their external positions. On such broader measures, 300 the appreciation of the dollar in real terms through early 1985 also was smaller. Exports .,,_- --....__, ------------- 0 The decline in the dollar over the past year was ~-..... ~--------- 20 associated with a fall in interest rates on dollar denominated assets relative to rates on assets denominated in other currencies. Moreover, some correction of the dollar's external value was seen to 1981 1983 1985 be an essential element in the process of reducing over time the huge U.S. current account deficit and proportion of the dollar's depreciation._ In a~dition, restoring better balance in the United States and since early 1985, the dollar has appreciated m real world economies. The apparently muted response of terms relative to the currencies of Canada and some the current account to the dollar's depreciation developing countries, which account for almost half through most of 1986 contributed to sharp down of U.S. nonpetroleum imports. ward pressure on the dollar in early 198 7. Meanwhile, the volume of merchandise exports The volume of merchandise imports rose sharply picked up last year. This improvement mainly in 1986, with increases widespread across products reflected the enhanced international competitiveness and countries of origin. Petroleum imports surged as of U.S. goods in foreign markets that stemmed from prices plunged. Domestic production contracted, and the decline in the dollar, as the pace of foreign eco nonpetroleum imports continued to grow at about nomic activity generally remained sluggish. Growth the rapid 1985 pace. In part, the sustained strength last year for the major industrialized countries as a of nonpetroleum imports reflected the relatively group was slower than in 1985, in part because of a moderate increase to date in prices of these goods; pronounced deceleration in Japan. Activity in many foreign exporters to the United States and U.S. dis developing countries was damped by subdued . tributors, whose profit margins had widened sub growth in the industrialized world and the contmu stantially during the period of dollar appreciation in ing pressures of external debt-servicing obligations. the early 1980s, were able to absorb initially a large Weakness in world commodity prices also has aggra vated the financial difficulties of many developing nations, including oil-exporting countries. 8 Monetary Policy and Financial Markets in 1986 M3 At its meeting in February 1986, the FOMC estab Billions of Dollars lished target growth ranges, measured from the fourth quarter of 1985 to the fourth quarter of 1986, of 3 to 8 percent for M 1 and 6 to 9 percent for both M2 and M3. The associated monitoring range for growth of domestic nonfinancial debt was set at 8 to 11 per cent. Based on the experience of recent years, the Committee recognized that the relationship between 3300 Ml and economic activity was subject to particularly great uncertainty. Accordingly, the FOMC agreed to evaluate movements in Ml in light of their con sistency with the patterns in other monetary aggre 3200 gates, developments in the economy and financial ,,,-""' markets, and potential inflationary pressures. ,,,-" / M 1 was well above its annual target range at the 0 N D J F M A M J J A S O N D time of the July FOMC meeting. The available evi 1985 1986 dence suggested that the rapid growth of M 1 reflected shifts in portfolios toward liquid assets in the context of declining market interest rates rather than exces concluded that M 1 growth above the existing range sive money growth with potential inflationary conse would be acceptable, provided the broader aggregates quences. Against this background, the Committee expanded within their target ranges, price pres- sures remained subdued, and the economy con tinued to expand at a moderate pace. The Committee M2 Billions of Dollars reaffirmed the target ranges for M2 and M3 at its July meeting. Committee members felt that growth within those ranges for the year was still consistent with the overall policy objectives of reducing infla tion further, promoting sustainable growth in out put, and contributing to an improved pattern of international transactions. In the first half of the year, the growth of domestic nonfinancial debt exceeded both its monitoring range and the growth of nominal GNP, as it had in previous years. The Committee was concerned about the burdens and potential instabilities associated with the persistence of rapid debt growth and felt that raising the moni toring range for debt would create an inappropriate benchmark for evaluating long-term trends. As such, the existing range was maintained, but the FOMC thought that debt growth could well exceed its upper 0 N D J F M A M J J A S O N D bound. 1985 1986 9 The growth of M2 quickened in the second half of able and more even expansion of activity across the the year, and M3 expanded at a somewhat faster economy. At the same time, however, the Commit pace as well. However, both of the broader aggregates tee was concerned that an unduly precipitous decline ended the year within-although near the upper in the dollar against the currencies of our major trading bounds of-their target ranges. The growth of M 1 partners could contribute to inflationary pressures in accelerated further in the second half of the year, the United States. To help limit the effect on the resulting in a record postwar decline in velocity for value of the dollar, the first reduction in the dis 1986. The growth of nonfinancial debt slowed slightly count rate was a coordinated action with other in the second half of the year, but still exceeded its major central banks; similarly, the reduction in monitoring range by nearly 2 percentage points. April was accompanied by a cut in the Japanese dis Pressure on reserve positions of depository institu count rate. tions, as reflected in a relatively low volume of bor rowing at Federal Reserve Banks, changed little over Money, Credit, and Monetary Policy M2 expanded almost 9 percent in 1986, placing this Total Domestic Nonfinancial aggregate near the upper bound of its annual growth Sector Debt Billions of Dollars target. Although in recent years this aggregate has ---------------------- exhibited a tighter relationship with nominal GNP than Ml has, its velocity still registered a decline of 4 percent last year and reached its lowest level in decades. The buildup of M2 balances relative to income probably reflected incentives to place savings in various components of the aggregate whose offer ing rates were falling more slowly than market interest rates. 6900 Mt Velocity Ratio of Scale .,,. .,,. .,,. .,,. .,,. .,,. .,,. .,,. .,,. ,, Quarterly 7.5 0 N D J F M A M J J A S O N D 1985 1986 6.0 the course of 1986. The broadly accommodative thrust of policy was manifest in the four reductions in the discount rate between March and August. In part, the discount rate cuts were intended to keep 4.5 this rate in line with the yields on short-term market instruments. They also were taken in the context of hesitant worldwide economic growth, an improved inflation outlook, and growth of the broader mone tary aggregates within their annual target ranges. In setting monetary policy the FOMC focused 3.0 considerable attention on the nation's trade deficit and the foreign exchange value of the dollar. The I I I I I I I I I I I I I I I I I I I I I I I I I Committee members generally viewed the narrowing 1962 1968 1974 1980 1986 in the trade deficit as a key to achieving a sustain- 10 The changing structure of deposit rates at banks expansion. Large CDs expanded only 3 percent on and thrifts has led to a pronounced shift in the com balance in 1986, with commercial banks paying position of M2. Inflows to transactions deposits, sav down their outstanding CDs during much of the ings deposits, money market deposit accounts, and year and thrift insritutions doing the same in the money market mutual fund shares were very strong fourth quarter. The weakness in CDs was widespread last year, while small time deposits ran off, marking as institutions relied more on other managed liabili the second consecutive year of zero or negative ties, such as term RPs, included in M3, and advances growth. from Federal Home Loan Banks, not included in M3. M3 also ended the year near the upper bound of The broad shift to liquid assets greatly affected the its annual range, increasing 8¾ percent in 1986. behavior of M 1. The narrow monetary aggregate Growth of M3 close to that of M2 is not surprising, expanded more than 15 percent in 1986, marking given that M2 constitutes four-fifths of the larger the second consecutive year of double-digit growth. aggregate. The remaining share is dominated by The velocity of Ml fell 9 ½ percent last year, com large time deposits and certain other managed liabil pared with a decline of 5 ¼ percent in 1985. Since ities of depository institutions. Credit growth at 1981 the velocity of M 1 has declined 16 percent-a banks and thrifts remained quite strong last year, remarkable development in view of its tendency to but with the exception of the first quarter, the use of climb about 3 percent per year in the previous two managed liabilities in M3 was light as growth of decades. Much of the rapid growth in narrow money core deposits largely was sufficient to fund asset over the past two years appeared to be related to the Growth of Money and Credit (Percentage changes)2 Domestic Period M1 M2 M3 Nonfinancial Debt Fourth quarter to 1979 7.9 8.2 10.4 12.2 fourth quarter 1980 7.3 8.9 9.6 9.6 1981 5.1 (2.4)3 9.2 12.3 9.9 1982 8.6 9.1 9.9 8.9 1983 10.2 12.1 9.8 11.5 1984 5.4 7.9 10. 7 13.9 1985 12.1 (12.7)4 8.8 7.7 13.5 1986 15.2 8.9 8.8 12.9 Quarterly Q1 8.8 5.3 7.7 15.4 growth rates 1986 Q2 15.5 9.4 8.7 10.3 Q3 16.5 10.6 9.7 12.0 Q4 17.0 9.0 7.8 11.5 11 effects of the sharp decline in market interest rates As a Percent of Consumer Installment Credit on incentives to hold both NOW accounts and Personal Disposable Income demand deposits. Since their peak in the latter part of 1984, short-term interest rates have fallen about 5 percentage points to their lowest levels in nine years, while NOW account rates have changed considerably 20 less. Although more rapid money growth generally would be expected in an environment of declining rates, the expansion of M 1 last year and in 1985 18 was in excess of what would be indicated by the historical relationships among money, interest rates, and income. 16 Domestic nonfinancial debt expanded almost 13 percent last year, a slightly slower pace than in the two previous years but still above both the Commit tee's monitoring range and the growth of nominal 14 GNP. Debt issuance by the state and local sector dropped off substantially from the pace set in 1985, when it was boosted by borrowing in anticipation of tax reform restrictions. 1982 1986 The Household Sector The Business Sector The expansion of household debt slowed last year as As long-term interest rates declined last spring to the growth of consumer installment credit receded to about 12 percent from the 15 to 20 percent pace of their lowest levels in eight years, the volume of cor porate bond issuance surge-cl to record levels. Indeed, recent years. Nevertheless, installment debt continued the volume of domestic corporate bonds sold last to-grow faster than income, and the ratio of such debt to income established another record. With mortgage year was nearly twice the previous record set in 1985. Much of the bond issuance last year was used debt expanding rapidly, the ratio of overall house hold debt to income also reached a new high. While to refund higher-cost debt or to pay down short-term credit. With the stock market continuing to register assets of the household sector have increased sharply in recent years, many individuals have experienced impressive gains last year, new equity issuance also difficulty in meeting their financial commitments. reached record levels. Of the gross proceeds from new equity issues sold last year, about 30 percent was raised by firms issuing stock in the public mar ket for the first time. The retirement of high-coupon bonds, the reduced dependence on short-term credit, and the issuance of new equity shares tended to improve conventional measures of corporate balance sheet strength. How ever, massive volumes of outstanding equity were retired through mergers, acquisitions, buyouts, and other restructurings, resulting in the third consecu tive year of large net equity retirements. 12 Because of the large paydown of equity, the abil The Thrift Industry ity of some corporations to weather economic shocks The financial condition of the thrift industry as a has waned. The weak financial structures of some whole has improved markedly since the early part of firms, along with strains in certain industries, led to the decade, but the difficulties of many institutions more than $3 billion of corporate bond defaults in have intensified. As interest rates fell from their 1986, an amount that dwarfs the experience in nearly elevated levels in 1981 and 1982, the average cost of every other year of the postwar period. funds at thrift institutions declined much more While the economy has grown continuously for rapidly than the average yield on their assets. The more than four years, the expansion has been industry as a whole returned to profitability in 1983, uneven and has left certain sectors under severe and aggregate earnings have jumped since then. Net strains. The problems faced by firms in the mining, income for the industry in 1986 probably was strong energy, agricultural, and many manufacturing again, although it is likely to have been below that industries are well known, as are those of a number in 1985. of heavily indebted developing countries. The diffi At the same time, asset quality problems have culties in these areas are feeding through to the become increasingly important for a sizable number financial intermediaries supplying them credit. Last of these institutions. While some of these problems year, for example, 136 commercial banks failed are associated with economically distressed regions of compared with a total of only seven in 1981. Many the country, overly aggressive investment strategies of these institutions had heavy credit exposures to of some institutions certainly have contributed heav the oil industry, while more than 40 percent of the ily. For 1986, about one-quarter of the thrift indus failed banks held large amounts of agricultural try will report negative net income, and the long loans. term prospects for many of these institutions are unfavorable. Moreover, the Federal Savings and Number of Downgradings Loan Insurance Corporation has inadequate in Moody's Corporate Bond Ratings* resources to manage these problems effectively. Regulatory and Supervisory Functions 180 While the many stresses and financial vulnerabilities are not amenable to correction through general 150 monetary policy, they do influence the economic environment and represent a potentially disruptive 120 and destabilizing element in the picture. The Fed eral Reserve has been called upon to play a positive role through its regulatory and supervisory functions. 90 For example, steps have been taken to reduce the risks associated with large payments made by wire 60 transfer, and several proposals have been made to ensure the capital adequacy of commercial banks. 30 Many of the financial and sectoral stresses will take considerable time to alleviate, and will require a stable monetary environment, redress of the imbalances in the nation's federal budget and international trade 1974 1977 1980 1983 positions, and-importantly-prudent private behavior, •The number of downgradings on a corporation's highest-ranking debt issues. encouraged as necessary by sound regulation. In April 1982, Moody's increased the number of rating categories by dividing most of its major categories into three subcategories. Only downgradings from one major category to another are counted. 13 Footnotes 1. Mt is currency held by the public, plus travelers' checks, plus demand deposits, plus other checkable deposits [including negotiable order of withdrawal (NOW and Super NOW) accounts, automatic transfer service (ATS) accounts, and credit union share draft accounts]. M2 is M 1 plus savings and small denomination time deposits, plus Money Market Deposit Accounts, plus shares in money market mutual funds ( other than those restricted to institutional investors), plus overnight repur chase agreements and certain overnight Eurodollar deposits. M.3 is M2 plus large time deposits, plus large denomi nation term repurchase agreements, plus shares in money market mutual funds restricted to institutional investors and certain term Eurodollar deposits. 2. M 1, M2, and M3 incorporate effects of benchmark and seasonal adjustment revision~ made in February 1987. 3. Ml figure in parentheses is adjusted for shifts to NOW accounts in 1981. 4. M 1 figure in parentheses is the annualized growth rate from the second to the fourth quarter of 1985. A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRB 11-48000-028 7 14

Federal Reserve (1987, February 18). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19870219

@misc{wtfs_monetary_policy_report_19870219,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1987},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19870219},
  note = {Retrieved via When the Fed Speaks corpus}
}