Regional President Speech

· . FUTURE ROLE OF THE FEDERAL RESERVE IN THE FIGHT AGAINST INFLATION Remarks by Roger Guffey ~president, Federal Re serve Bank of Kansas City Economic Club Ok l ahoma City , Oklahoma November 24 , 1980 -, The last time I was invited to speak to this group in February two years ago, a heavy snow storm hit the area and, much to my regret, I was unable to make it to Oklahoma City as s c heduled. This time, thanks to the scheduling foresight of ~1k-$ , t he pleasant weather today is much more accommo­ dative as w-ll as typical of Oklahoma weather during the fall; all of whic h makes it a particular pleasure to be with you here serious economic problems that currently afflict our nation. The list of these , problems is discouragingly long: slow economic gr owth, hig~ ~ ~ unemployment, energy shortages, lackluster productivity gains, high and volatile interest rates, and , of course, a chronic of Tlc..ese...... inflationary situation. The most in my judgment, and seriou~ C,4;l.(s-e perhaps the pr incipal of most of the other problems 0&UsaL=~e~Gr LV~tP 0; 7""/~ ~ is the cancerous-l i Jfel\inflatio ~el!E:i~~tI!r that is now virtually /l/.-97;~ strangling the very economic vitality of this ald ••~¥. It is appropriate, t her e fore , t hat I take t his opportunity to disc~ss 7oIjl;~h-r . 6>T2h:J~ \V.i th you here .,t;g K"!I" the role of the Federal Reserve In ,t ~K...ight against inflation. ~ In approaching this topic, I believe i t would be if I first briefly reviewed what the Federal Reserve has done over the past year in the fight against inflation. In -2­ doing so, I want to respond t o cer~aip' crit i cs of Federal --t:Jd: ~-:f'-J~~ a~ Reserve policy who have allowed the money supply clai~wo interest rates to f luctuate much too widely. And then, secondly, I want to comment on the econom,ic outlook, with particul~ an~conomic implicatio~o~Federal emphasis on the future role Reserve monetary policy . Looking back at the past year, none of us can be very pleas e d with the performance of the economy nor with the record thatte~ed on inflation. Indeed, it was out of concern that inflation would accelerate in 1980 that the Federal Reserve announced in October of 1979 the adoption of new operating pro­ cedures designed to improve our control over the growth rate of the money supply. Underl ying this change in procedures was 1/}<2.4l~...l, the recognition that~reduction in the growth rate of money is a necessary ingredient to eventually reducing inflation. To be sure, the Federal Reserve has for some time established target ed fQX,money believed appropriate_f or t he gr?wth ~at~s ~ ~~~ wdJi. ~ ~~.., ~ ~;,~ , economyf,J bue our record has not be en very good i n acfuallY achieving those annua l money suppl y targets. Thus, it was felt, to better control the growth of money over the l ong run, new operating pr ocedures wer e necessary t hat would pl ace less emphasi s on pegging interest rates in financial markets and emphas~~ies~~nking more s ystem. . The se new procedures, and the coincident shift to a monetary poli c y of firm restraint, have been severely tested -3­ dur ing the past year. . Indeed, the economic circumstances In which the ? ederal Reserve has operated during the year ha ve y~~all, been e x traordinary. At the outset of 1980, as there was a marked acceleration of inflationary pressures and expectations brought about by higher p: ices, the Middle oi~ " ~/~d ~ ~b l~ d East crlsls,~rowlng concern a outA.arge e f l " ~~~ , n~ h pr~ ff Federal bu get. These inflationary were t if instrumental in driving up interest rates to historically high levels last spring. And, as a result of thGse high i n terest rates, business activity posted a record decline during the second quarter. As a fallout of the economic downturn in t he second quar ter , ~7k~.$f~ the demand for money and credit declined rapidly ~interest rates also fell sharply. Under our new operating procedures, Wli.a,. the Fed A much more tolerant of this decline in interest rates be cause we wanted to keep money growth within our targeted ranges. Because of this policy, the sharp decline in interest r at es se rved to break the economic downturn and set the stage recovery~~uarter. for a business Also, because of tfrdnot this policy, the unemployment rate rise... t o the very high l e vels that were earlier forecast. In recent months, the business recovery has been somewhat str onger than gener a lly expected. And, reflecting this business ~)Ih1~4''V upturrf,f , cont inui ng high rates of inflation, the demand for money and credit has risen shar ply once again . Th~~.~, T-..r--·" ~~ ..&-n /~ Federal Reserve has r es ponded to this r ecen%H* liQol1 in a I -4­ manner perfectly consistent policies. In order ~th-&1r~~in our targeted ranges, no~~, rat~iciallY we have to keep interest low levels. Rather, we have allowed interest rates to move freely in financial markets, i V -tJb..e ~ief that-in these inflationary .?n ~ ~ times-it is more importa~ p event an excessive growth rate of money. Iil assessing our record with respect to monetary control, it is of course true that the money supply has moved in an ~~ o-rt- <l..---' erratic fashion on a week-to-week ~o~01-0~~~ You should be aware, however, that if ~W? REP prevented these J 7 , ~ _» I~ swings, it would lB8.a~5~d~b;Q.2R~ necessary for inter est rates to have 0JCm ~ move. in an even mo re volatile manner than Aactually occurred. ~ ,~ Thus, there between the control of money in the is~trade-off sho rt run and the volatility of market interest rates. I would further point out that it is not the month-to-month or even the quarter-to-quarter movements in the money supply - ~~ that~! ! L, but rather the longer run trends. In this regard, I should emphas i ze that, despite the difficult circumstances in whi c h we have operated this year, the monetary aggregates currently stand in reasonable alignment with the ranges set for the ~ year- although on average they are a bit higher than we would l i ke . In retrospect, therefore, I believe the Federal Reserve has played a significant role in the fight against inflation this year. '07e have, i n a very determined sense, fOllowed~OliCY of monetar~__~_L=tt , ~·~~u--7J restraint. And, that policy has helped to cont inh i nflationary I -5­ expectations in the face of some t roubling developments that would otherwise have led to substantially higher inflation. By so doing, however, we have also played a r ole in the recent increase i n i nterest rates. While a rise in interest rates c a nnot be cons i dered a favorable development at this stage of a busine ss ~~ recovery, I firmly believe that a shift to an easier in order to bring interest rates back down would not be wise. If we did so, quite likely the result would be an increase in inflationary expectations, higher interest rates later on, and a worsening in future economic activity. All of whlch brings me to the question of the future role of t he Federal Reserve in the fight against inflation. On this matter , I want to be brief and to the point. In the period ahead, in my judgment, there is no doubt that the Federal Reserve will continue to follow a policy of firm monetary restraint. Such a policy, which has already been announced in general terms, will be directed at achieving a slower growth rate of money in 1981 than in 1980. Havj_ng said that, I want to hastily add that none of us shou l d be deluded into thinking that a significant r eduction in pri ce inflation is lik~ly ~o be achieved soon or that the task will be o-V~~. e a sy ~ painlessfL-In a ve ry r eal sense , significant prob lems . I)~~ ~ w~llA develop i n the economy as t he momen tum of a decade of inf l at ionary exp ectations collides with a policy of firm monetar y res traint. To prevent such a collision from having a sharply negative - 6­ impact on the level of business aC~~~ ~i~ 1981, it lS ZS'?..AZ~t~s~ ~ role of that no t be cast in the I :;,~ .!!Nalone. In short, the role of the Federal 1, I ; I ~emelY Government's fiscal policy important at this time.~ ~ ~~ 6.e. <!1'I4_~' poi nt in 62-M.. What many people are now hoping for, i ncluding many financial market participants, is that fiscal policy will begin to play an active and role in the fight against inflation. And, ~eaningful ~ f or that role to b~effective, in my judgment, the new Administration - must indicate at the outset that it will be taking firm, clearcut, and cr edib le steps to r es tore balance t o the Feder al budget . As you know, a ba lanced budget can be achieved in a number of ways. One appr oach, which has been the practice in recent year s, i s to follow up large spending increases by raising t axes and allowing inflation to push up government revenue. Clearly ,~th~ ype ~;[~s not fight inflation. tl P1tne a proach, and one that is needed in the period ahead , ~ft8ER@f is one that will hold down and even r educe government spending. And, to the extent tha t spending is increased and some defen~e taxes reduced, it is even more important that a lid be clamped on nondefense spending. Only in this way will the budget be balanced in a noninf lati onar L way. In brief, what is vitally needed in the fight against inflation is not just a continuation of a restrictive Federal Re serve mone tary policy. What is also needed is a coordinated and r est rict i ve spending policy on the part of the Federa l Government. -7­ A third ingredient for a successful anti-inflationary program, bes ides the application of restrictive monetary and f i scal policies, is the acceptance by the general publ ic of these policies. The publi c must be willing to support economi c poli c ies that promise long- r un benefits but entai l--in the short run--a period of economic slack and high unemployment. The extent to which the public will support such a program &d.R depend upon the length and magnitude of the period of .-?UJ L7T.~~ economic slack. UnfortunatelY'A~ kno~how long or how severe the period of slack will need to be. Some people fear that a lengthy period of adjustment is requiredj while others believe a short period will be sufficient. Those taking the opti mistic short-term view stress the importance of affecting t he public' s inflationary expectations. If the public becomes convinced that the Government's policies will be effective ~ in reduci~inflation, , actual prices in the marketplac e will not be bid up a s rapidly. I beli eve ther e is some merit i n this latt er view, and , therefore, I believe economic poli cymakers now have a unique opportunity to affect the rate of inflation. As you know, a new Admi nist ration and a newly constructed Congress have a 0 ti l 2dl_ number of options open to t hem. If the new Administration were to seize this opport uni ty and clearly enunciate a policy of fiscal restraint involving a firm lid on government spending and move to a balanced budget, I bel ieve it would go a long way in breaking the rising momentum of inflationary expectations and pressures that are building up for 1981. . .... , .... r • , - 8­ In conclusion, we should all have no doubt that the application of persistent and credible policies of monetary and fiscal restraint lS absolutely essential to an effective anti-inflationary program. We should also be fully aware that the application of such policies will inevitably result in a temporary dampening of business activity. However, I firmly believe that the long-run benefits of such policies to curb inflation will far and away exceed the short-run economic costs . Only through a reduction in price inflation, in my judgment, is there any real hope for attaining both lower and more stable interest rates, an environment conductive to increased capital investment, to a growth in productivity, and to higher ~ and sustainable levels of employment and national income. For that reason, therefore, I want to assure you that whatever the course of fiscal policy in the period ahead , the Federal . ~~~~Y1Ci-~~ Re s e rve System will conti~ue~ . in the all-important battle against inflation.

J. Roger Guffey (1980, November 23). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19801124_j_roger_guffey

@misc{wtfs_regional_speeche_19801124_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1980},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19801124_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}