Regional President Speech

.. , THE MERCHANTS BANK BOARD OF DIRECTORS MEETI NG Kansas City Club June 26, 1984 I am very pleased ~u invi~hare this yo:JI..t.P~ ~.; 4 I!!!! " bUIi±- occasion wi th Y<1l;ir ,,,,,eeao, .. fJ mu:, ~b T,·lioely recogflizee and re5poc1:od for hi s perceptive aml e~etic ~Us jness l Qaeer~h~. We in the Federal Reserve always appreciate opportunities to meet in gatherings l ike these to consider lssues that concern both the Federal Reserve and . ~ '.-----------------~ business people everywhere. In particular, I know that we - share a mutual interest and concern about the health of our , nationa l econom~. Therefore, I would like to visit with you t5?1lt~ about the current economic situation and about the role that ,monetary and fiscal play within that outlook. polici~s In discussing these issues, I am acutely aware that central ~ bankers often are prone to take view of the world, In ~ somber this connection, I am reminded of a remark I heard recently that • -t:t£~ central bankers are very much like~ puritans. They have a haunting fear that someone, someplace, may be happy! Naturally, a s a central banker, I don't want to fallout of character and l eave you too happy. However, I do promise to be as objective as po ssible, looking at both the significant progress we've made recently in terms of economi c performance as well as the problems and chall e nges we have yet to face and resolve. * * * * * * * First, then, let's look at the current economic situation. As you all know, economic growth was surprisingly strong in 1983 and on into the first quarter of this year. Industrial prodlction has shown continuing strength and idle capacity has declined. Housing growth nationwide has exce eded e xpectations and au~obile sales have rebounded vigorousl y from recession~ lows. -Wi t hO the unemployment ra t e continuing 0 move downward and personal income rising, more consumers have had more do llars to spend. As a result, retail sales have continued to lead the economic expansion and businesses continue to place orders to rebuild their inventories. Reflecting this strength in the economy, businesses have stepped up their spending plans for new plant and equipment. Given this momentum, I believe the economy will remain strOng~hout 1984, although some moderation in the pace of growth become evident later in the year. ~ A key factor in the economic outlook for 1984 is the role that monetary policy will play. As most of you know, monetary policy has earned considerabl~ibility in the financial markets PUbli~ and among the American This credibility results from the Federal Reserve's consistent adherence to a firm anti-inflationary policy in recent years--a policy which is generall y credited for" much of the success to date in bringing inflat ion under control. Let me a s sure you t hat the Federal Re~erve r emains committed to prov i d ing money and credit to t he economy at a pace which will .... provi e for a sustainable business e xpansion wh ile, at the s ame time, m-aintaining progress toward price stabi lity. * * * * * * * Given this favorable economic outlook, what then has happened lately to cause ge~eral concern on the part of many -3­ people? Why, for example, have ...interest rat c.s In the money a.nd capital markets risen past month or two, and why have ov~r~e ~~.z;;'xe ? equltY ' prices come dow9f:tilliflJ I at e"t~.f? Moreover, .wCa5' It Ii i.~ ij~ge <\i> J J or "Q_keRes l,,".ly ;, A £9Fe ; mOl k, "" " Lee t L a '-'l:J rlit"gsTli H:i'i!AS laEo la st 1 ' {U mAli why are some people talking about a possible downturn in business activity in 1985 or 1986? The answer to these questions, in my judgment, is that there is a basic concern that our economy may be in the process of tracking the boom-bust business cycle so typical of the 1970's. During that period, as you recall, whenever there was a downturn in th: ~2 ' aLa economy;lexpansionary policies were promptly adopted by economic policymakers. Unfortunately, those policies tended to be held in place much too long. As a reSUlt, inflati on increased sharply anr conomic g'rowth eventually was halted in its track. Currently, as I've indicated, we are again in the e xpan­ sionary phase of the busine ss cycle. Indeed , some people tod y are concerned that the pace of the expa nsion is pr oceeding t oo &#45;&#45;&#45; rapidly. Unlike pr e vious per iods , though, Federal Peserve monetary policy is not contributing to an excessi ve growt h l D the economy. Rather , we are intent i onal l y gear ing policy t o provide for a moder at e and sustainable economi c growth rate . ----------------------!~ . ~~----~----~--- At the same time, though, the government's fiscal policy is continuing to provide thrust to the economy an ~xpansionarv through enormous-ly large budget deficits. - 4­ Thes e budget deficits, which a re large as far out into the future as one can reasonably see, lie at the root cause of . -u; the current mala ise markets. The cre dit markets i~financia l realize, I believe j that despite the current robust condition of the business expansion/ large budget deficits threaten the very vitality of the American economy. Most certainly, the recent upward movement of interest rates/ th: weakness of stock pri~el .. J?, ' E 15 bJA62UifZr , and the concern about a reemergence of inflation, all stem from the view that the government's budget deficits are incompatible with a healthy u.s. economy. Since these deficits are the most serious economic problem likely to affect our economic future, I want to discuss them more fully with you. In thinking about the economic impacts of budget deficits, it is useful to remember that deficits in and of themselves are -- not necessarily bad or inappropriate. For example, when the economy is struggling to overcome recession, such as in 1981 -and deficits can be useful to generate growth and employment ~ , by increasing the government's demand for goods and services. But when the economy recovers and begins to grow s t rongly, such as in 1983 and early this year, deficits are not needed to ~ encourage growth and, in fact, lead to serious problems. These problems are manifested in terms of higher interest rates,~ a renewal of inflationary expectations,j and a reduct~n in the economy's potential for further ecoriomic growth. -5­ First, let's consider the impact of large deficits on .... .---. i ?erst,s t ras.es. Because budget deficits must be financed by borr owi"ng iii credit markets, massive ongoing deficits increase ---g;. the competition for/ available SUPP1~ of credit. Moreover, as economic expansion continues, rising private sector credit - from businesses, farmers, and home buyers will collide Qgm~ds - . ~<------------- with the government's borrowing needs. As this occurs, interest rates tend to be higher than they otherwise would be and the private sector is increasingly "crowded out" of the credit markets. In 1983, this type of "crowding out" occurred only to a minor extent because our domestic savings were supplem-en-t­ed by a heavy inflow of foreign capital. A second concern related to the large federal budget deficits is the problem of .r..ising inflationary expectations . As the economy continues to expand, and as growth in public and I private c-redit demands put upward pressure on interest rates, public fears about renewed inflation become more widespread. These concerns may affect individual and business decisions about wage~ , savi~g, ~ i~vestment. spending, Occurring in combination with rising interest rates, such renewed inflati onary expectations seriously damage the foundation of sustainable noninflationary - growth we have put in place at such a great cost in recent ye ars. ~ I am concerned, as well, that some misguided l.bs 9Awi ll call for the Federal Reserve to ease the deficit financing ~ting problem more money. I believe that most thoughtful -1)­ people now realize that creating an excessive supply of money and credit is cle arly not a viable s olut ion to massive ... ~ federal deficits. Such action would only add ~public concern about future inflation and rising interest rates. Moreover, considering how far the economy has ~o~~~h~ far ~~-~ - in the fight against inflation, it would ~irresponsib..l e for us to fore sake these gains by monetizing the large deficits. Although the ne-ar-term problems associated with the - deficits are very tro-ublesome, the continuing large budget deficits the so-called "out years" also introduce ~n major risks to the nation's economic futur e. These risks go ~ beyond questions of rates and inflationary expectations i~terest and are related directly to the role of private decisionmaking in our society. Accelerating federal, state , and loc 1 government spendin~ ~~d transfer payme~ts now equal nearly ~ per cent of our nation's gross national product. This large and growing size of government r a i ses serious questions about the future of the private se ctor. I f government continues t o absor b a dispropor t ionate share of private savings to finance programs and defici ts ,;'it is clear that we r~ up much of the private investment so 53( ~u neces sary f rea 1 economic growth . t, more important ,l y / a reduced private sector surely means a declining role for market forces and, thus, weaker incentives for the initiative and -7­ innovation so characteristic of the American people. In short, the large government deficits are no t only incompa t ible with ~conomic ~ n(e.-a-r-term stabifity, <2 they also are incompati 18 with the long-run health and vitality of our free enterpri-se system. Given this view, there is every reason for the American people to de-m-a-n­d action now on the deficit issue . ....... The deficit-reducing plans now being discussed--including the so-called "down paymen. t" schemes--are classic examples of too little and too late. Such plans stop far short of the necessary action. They do timely help because their effects no~ovide i'''' ~;J?;:":' f.':-'"IlC ~....~ into the f u t ure . But more irnpor tantly , the reduct\ons they propose are far too small to have any bU~ ~~~~ on the economic impacts of the defici; s. re~effect o~ushing In my judgment, we are not yet facing up to the magnitude of the problem before us. of for action on unfortunately, ~ndOw opport~nity the deficit is cloSinji r ap idl y . I say this for ~everal re~ns. The most obvious reason is that the economy is now growing much more rapid y than earli er expected . Quar t er after quart er , we see the economy's surprising staying power , that suggest~ng the clash of public and private credit dema nds may even now be upon us. Another reason for believing that the time frame to act against the deficit is shrinking is that foreigners may rap~dly not be willing much longer to continue to invest in the U.S. -8­ economy. They increasingly see the U.S. economy as one that is living beyond its means, as evidenced by persistent budget c...------­ deficits deficits in our interna ' onal balance of payments. a~d "'" - ....... The problem here is that, if foreign capital flows dry up, interest rates in the United States will rise as the full brunt of our domestic credit demands falls on the liwited supply of our domestic savings. Foreign exchange markets recognize that, as the United States continues defici~s;4~qlas tur~ , to incur large international trade we, in resort to heavy foreign borrowing to finance those deficits, this nation will rapidly become a net debtor nation. If this trend continues, it is natural that foreign lenders will increasingly q~i~e~ttractiveness of u.s. market. These lenders also willAque§tion the underlying strength of the U.S. dollar. A further reason for believing that we nee d to act now /'JJ;L. against the budget deficits is the of possib~emergence inflationary expectations. Many observers expect that the rapid business expansion that we are now experiencing will naturally prompt price ~~s for goods and services ~~a~ evaporates. ~,\consumer and producer pric~indexe!A~ ~_Cc Should an increase in prices Ie d to inflationary wage settlements later this year, the r es ulting upward cost biases would carry into 1985 and 1986 'to: .. and threaten the relative wage stability which has contributed so much to recent productivity gains. econom~ With so much at stake for the future health of the I know many of you my frustration over the paralysis ~ share~ ~~~ a which iQ_£ ~ the deficit problem. The root problem, it seems to me, is that the deficit is not just an economic fC- -::':';~JC; problem, but an economic problem requirinj..t political ~~,..' Moreover, the situation is compounded because this pr oblem requires action in an election year. The combination of these " ~- - circumstances has led to the prevailing attrtffiR?r that nothing meaningful can be done about the deficit now. I reiect t hat view. . I rejec t it .because the economic deficits are solely a matter of public polic..y . They are not something that we cannot control. Rather, they are controllable if we wish to change our publ ic policy. As such, we do have the power at our disposal to ~ct~ thkough t he deliber ations of the American peoPly ...... the ~~~ . and we c a n begin right now. Congress ,~ ~ . The politi cal realities of finding workable de ficit­ r e d uction proposals suggest that the most likely avenue for . _ ­ proaress is through some combination of spending cuts and tax - ~~~ increases. f It is not )the province of the Federal Reserve to decide where, when, or how to cut " S~i~~~ues. Such matters appropriately rest wit~t':he <aoR~rE_s. But l.t -10­ seems to me that we soon must agree o~princiPle~~ guid our actio~at this critical juncture. 0ne important objective of any plan to reduce the de ficits, - in my judgment, is to preclude any further growth in the role and size of government in our society. Accordingly, I believe ~ » any deficit reduction plan should give greater weight to curbing government spending and lesser weight to increasing government < ~ taxes. Converting such a desirable objective into practical policies is challenging but, nevertheless, in my judgment, attainable. Congress could, for exam.p. l e, seek to develop a program of spending cuts and tax centered around a modified increa~es freeze on government outlays at the 1984 level. This approach ~ would freeze only the level of real expenditur..e s an51 permlt growth in upcoming years no greater than the rate of inflation. The bottom line is no further expansion--in real terms--of government outlays. This appr oach would impose no cutback an~ibute from current spending levels future constraints equitably across all spending pr ograms . - Putting real numbers to this appr oach provi des some t:h1 interesting results. ~ analysis i ndicates that, a t zero real r ~wth in government spending in 1985 , 1 986, and 1987 , the - administration's anticipated 1987 deficit of some $200 billi-on would be cut to about half that level. Adding sel e c t ive t ax rr"---­ - o increases to the mix could reduce that remaining 1987 deficit to r . . -11­ $50 billion or so, moving the prospects for a balanced budget back into the realm of possibility. Adoption of this approach I have -desc" ribed would offer another very important byproduct: - , it would reduce government spending as a PfQPortion of GNL from = about 25 percent in 1983 to 21 percent- in 1987, given reasonable assumptions for economic growth. I realize, of course, that this approach is only one of many possible solutions, and that difficulties may arise in its implementation. Which reminds me of a story Will Rogers once ""I told during World War I when he heard the U.S. Navy was having difficulties detecting and destroying German submarines: "The . ,... &#45;&#45;&#45; solution is simple," he wired the U.S. Navy, "all you have to -----------~ do is boil t~eA ocean. Since you have the solution," he continued, "don't trouble me about the details." All of us, of course, must be concerned about reducing the government deficits as well as how they are reduced. Both . <= ~ ~ actions will have an important bearing on the near-term economic situation and the long-run health of the American economy. Whether the approach I have discussed is the best solution, I cannot say. What I can and must s ay is that the time to act is now. The urgency is clear. We must face the deficit issue with courage and discipline. If we do so, I am confident that the remainder of the 1980's will be a period of economic growth and price stability that we can all experience ~' ~V ~ ~ with a great deal of pride. ~----------------~---------

J. Roger Guffey (1984, June 25). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19840626_j_roger_guffey

@misc{wtfs_regional_speeche_19840626_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1984},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19840626_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}