Regional President Speech

THE ECONOMIC OUTLOOK: PROSPECTS AND PROBLEMS Remarks by Roger Gu ffey President, Fede ral Res erve Bank of Kans as City Kansas City Societ y of Fi nancial Analyst s Kans a s City, Missouri November 13, 198 4 Yo ur kind invitation to meet today with the Kansas City Financi al Analysts was welcome, indeed. As you know, we at t he Kansas City Fed do appreciate opportuni ties to discuss issues which concern both the Fe de r al Rese rve a nd people in the financi al community. Focusing again on economic i s sues is in some sense a rel ief several months of heated political exchanges l eading up to aft~r the national election l ast week. Just between you and me, I'm not s ure why anyone woul d want t o be president of the united Stat es. It's a j ob wi th no chance for promotion..•and they even make you l i ve in company housing! But unlike the pol itical audiences of recent months , who l ooked for rhet orical fireworks, audiences of f inancial analysts expect central bankers t o deal soberly with the more weighty economic issues of the day. In t his connection, I' ve heard i t said that central bankers are like Puritans. They have a haunting fear that someone, someplace, may be happy . I promise to stay in character today . My message includes a view that the nation's economy is in relatively good shape now, but that there are fundamental problems that demand the attention of policymakers. HOW those problems are addressed will, in l a r ge measur e, determine the nation's econom i c future . Let's look first at the current situation. As you know, t his month marks the second anni versary of t he economic expansi on which began in November 1982. As you also know, this expansion -2­ has been outstanding in many respects. Spurred initially by a drop in the rate of inflation, and then urged on by the decline in short-term interest rates that began in 1982, economic growth was remarkably strong in 1983 and through the first half of thi s year. As it has turned out, 1983 and 1984 has been the strongest period of u.s. economic growth in nearly four deca des. All in all, the past two years of economic growth have provided compelling evidence of our economy's breadth and power. In particular, we can t ake pride that our economy has already ~ creat ed more than 7 mil lion jobs during t he expansion. Moreover , we can point to many other specific positive developments, such as capit al i nvestment--which i s up 25 per cent in real t erms over t he period. But most of all, we are pleased t hat the confi dence of cons umers and businesses has been restored after a per iod of stagnat ion and recession. A major reason for the restoration of confidence i n t he nat i. on' s economic fut ure is, in my judgement, the absence of excessive inflationa ry pressures. After two yea rs of fai rly rapid economic growth, inflation remains a relatively moderate 4 per cent or so on an annual basis. As you would expect--given our commitment t o anti-inflation policies--we in the Federal Reserve a re gratified at the progress wh i ch hasa been made s o fa r. Though t he economic news has been basica lly good for two years now, t he recent slacke ning in the pace of business growth has raised questions about the l ongevity of this expansi on. As you know, the economy slowed sharply t o an annual rate of 2.7 per ce nt in the third quar ter , down sha rpl y f r om 8.6 per cent rate -3­ posted in t he firs t half. By and large, the summe r slowdown reflected an easing in consumer spending a nd generally flat final sales. This slowing of the economy has been accompani ed by decl ines in both short- and long-term interest ra tes. These declines have not been offset by upward pressures on rates from continued large government bor rowings. Fed funds are trading some 250-300 basis points below early-August levels, while long Treasuries are some 200 basis points less than in June. Incidentally, yie~ding such declines suggest t o some observers t hat the Fe de r al Re se rve has eased aggressivel y. However, I would di sagree, pointi ng out t hat t here has been no increase in total reserves during t he period i n question. Moreover, there has been no decline in the discount rate and the narrow money supply, MI , has remai ned well wit hin the l ower part of i ts t arget range. Thus , it should be cl ear that market f orces--not the Federal Reserve--have been the major factor i n the drop in int erest rates . But despite the undeniable benefits to our economy of more moderate inflation and lowe r interest rates--developments that have certainly helped restore confidence in the future--a number of problems remain to be addressed before we can feel f ully optimistic abo ut the longer-term health of our economy . Many of these problems are related t o adj ustments required in moving from a period of rapid i nf lation and high i nf lationary expectations to a period with a more moderate inflationa ry outlook . As you know, many decisions made earlier in anticipati on of ongoing inflat i on continue t o plague bus inesses and f i nancial institutions during -4­ t he current period of disinflation. The consequences of those earlier inflation-biased dec isions often are not easily managed and, taken togethe r, complicate the search for solutions to our economic problems • . Against that background of strong business growth and moderate inflation, I would like to consider with you bri efly the outlook for the nation' s economy . Before giving you my impressions of the near-term prospects for continued business .. growth, I want to examine the potential for the nation's long- term economic health. In so doing, I want to note some problems which, in my view, may block t he path to the sustainable noni nflationary growth that we seek. These probl ems , which incl ude t he high val ue of the dol lar , the st rains affecting our financial insti tutions, and the fede ral budget deficits , are i nterrel ated. u. s. One problem is t he int er nati onal st r ength of t he dollar resulting fr om our relatively high interest rates and our relatively favorabl e business climat e. With the dollar so high, u.s exports have been weak as domestic producers have been priced out of world markets. Overall, the poor performance of the export sector has caused the current business expansion to be unbalanced. Our own region, in particular , has suffered because agricul t ural producers have lost many export sales and other sectors serving agr iculture have been robbed of t heir potential growth. At t he same time, the flood of import ed goods priced in weaker cur renci es rel a tive to t he dollar has contributed t o the serious imbal ance in our trade position, while stealing sales from our domestic businesses. -5­ To be sure, a st rong dol lar has brought our economy some t emporary benefits. One is that the inflow of foreign capital has helped in the short run to finance both the business expansion and t he federal budget deficit. Another benefit is that the availability of abundant foreign capital has kept our interest rates l ower than they otherwise might have been. But these so-called benef its have cert a in undesirable side effects. Some observers have point ed out that the United states is rapidly becomi ng a net debtor nation, an unfamiliar situation, indeed, ~ for the richest nation in the worl d. When the international val ue of t he dollar event ual ly dec lines, which it must, t he consequences of t hat decline will present mixed blessings, at best . On the posit ive si de , a l ower dollar will cer tainly improve t he compet itive posit ion of U.s. goods i n worl d mar kets and boost our lagging export sector. However , a falling dollar could put upward pressure on domestic i nterest rates--as foreign capit al moves elsewher e. Moreover , a decl i ning dollar could lead to some inflationary pressures as f oreign goods become more costly and as domestic businesses lose some competitive price discipl ine. In any case, the strength of the dollar i s a problem now and a decline in its value may present other serious consequences in t he future . In addi t ion to the strength of the dollar , a second problem that complicates the outlook for the economy is t he continuing strains affecti ng our financi al inst i t utions. One highly visible aspect of this problem is t he inabil ity of many lesser developed countries to repay or service their huge debts on t i me in t he -6­ face of worldwide recession and disinflation. This situation has raised questions about the earnings and capital positions of many of the world's major banks. Fortunately, it appears that lower interes t rates, restructured loan agreements, and worldwide economic growth have begun to remove some of these pressures. Nevertheless, resolution of the problem will require considerable time and its effects will add a precautionary flavor t o the outlook for yea rs to corne. Though t he int ernational debt crisi s dominated many of t he headlines over the l ast two years, financial inst itutions have also been beset by domestic troubles , as well. An extended period of high interest rates- -caused, in my vi ew, by the f ederal budget def icits--has created continui ng difficulties for many business f irms , particul a rly in agri cul t ure and energy sectors. These probl ems , in t urn, have been fel t by financial i nstitutions struggling t o help finance the economi c expansion. Fi nancial deregulation has al so cont r ibuted t o the problems of f inancial insti tut ions . thr ift instit utions and a high l evel of ~Teakened bank failures are symptoms of such problems. A third--and the most troubling and pervasive--problem clouding the economic outlook i s he current and prospective Federal budget defi ci ts. Now, I don' t plan on "preaching to the choi r" t oday because I am sure t hat most of us he re share the conv iction that meaningf ul act i on on the budget deficits would bring l ower i nt e rest rates , encourage investment, contribute to continued progress aga inst inflat ion, and set the stage f or a sustained peri od of economic expansion. -7­ Though I don't plan to detail aga in the mul tiple perils of the defici ts, I do want to emphasize aga in my own bel ief that their reduction and eventual elimination would remove a persistent thorn from the side of the nation's economic potential. Not only that, progress against the deficits would help resolve the ot her problems I have noted. Does anyone not believe that real deficit reductions would reduce real interest rates and diminish the inflationary biases gene rated by such massive deficits? Such a result surely would help relax upward ~ pressure on the dol lar and permit u.s. exports t o compete more effec tively i n world markets. If t he dollar ' s relative value could be reduced gradual ly, a se ries of or derly adj ustment s i n international financi al and commodity markets could take place. Fur t hermore, if defici t reductions ease interest rat e pr essures, our f inancial institutions coul d ant i cipate f ur ther relief f r om t he st rains I described earl ie r. Thus, i n t he f inal analysis, a meaningful deficit- reduction program is a necessary step in resolving the problems clouding the l ong -term economic outlook. Moreover , in my judgement, such a program is essent ial for the ultimate economic health of the nation• . Given that background, now let me turn t o a brief discussion of t he economic out looK for 1985. On this count, I remain optimistic t hat moderat e and sustainable econom ic growt h wi th relatively l ow inflation can be achieved ne xt year . I say t his because of recent developments t hat appear t o have set t he stage for such a n outcome . -8­ For one thing, interest rat es are declining. The most important reason for this development is that credit demands have weakened as the economy shifts from rapid growth t o a more sustainable pace . But I bel ieve that recent interest rate declines also reflect optimism about the course of inflat ion. Downwa rd pressure on oil prices and continuing moderation in wages and commodity prices are helping to reinforce reduced inflat ionary expectations and to preserve real income gains. Given this posi tive t one, I believe that households and ~ businesses wi l l be encouraged to continue t o lead the expansion. These developments and t hei r effect on the outl ook are in line with economic projections made recently by the members of the Federal Open Mar ket Committee. My colleagues and I collectively look for real GNP growth next year in the 3 per cent range , with prices r isi ng perhaps in the to 5 per cent range. 4~ We see unemployment i n the fourt h quarter of 1985 averaging about to 7 per cent . 6~ As always , a key f actor in the economic outlook for 1985 is the role that monetary policy will play. As most would agree , monetary policy has earned considerable credibili ty in the financial markets and among the American public because of our consistent adherence to a f i rm anti-inflationary policy. This policy i s generally credited for much of the success t o date in bringing inflation under cont rol . Thus, it will not surpr ise you much when I say t hat, for 1985, the Federal Rese rve remains committed t o providing money and credit t o t he economy at a pace which wi ll provi de for a sustainabl e business expansion while , at the same t ime, maint aining progr ess t oward price st abil ity. I -9­ should point out that the tentative growth rate ranges for the monetary aggregates previously announced reaffirm our stated intention to reduce, over time, the growth of money and credit. In contemplating prospective developments in money and credit, we in the Federal Reserve are monitoring the situation closely. If we see signs of further economic weakness and continued slowing in the demand for money--as reflected by recent trends in money growth--we would expect furthe r declines in interest rates. What the Federal Reserve seeks, of course, is ~ for interest rates to come down and stay down so that greater investment and conti nued economic expansion will be encouraged. Howeve r, given t he Federal Reserve 's commitment to a policy of moderate growth in money and credit, and given no resol ution of the deficit issue , a rapidly strengthening economy would undoubtedly reverse the course of inter est rates. In summa ry, the economy has grown steadily over the past two year s, and i t should continue to expand through 1985 . The pa ce of expansion next year may be somewhat mo r e moderate t han the earlier rapid growth, but t hat is to be expected in a maturing expansion. Over the longer term , howeve r , the ultimate health of the economy depends, in my view, on meaningful reductions i n the huge Federal budget deficits. Such reductions would help impor tantly to bring about orderly domest ic and international adjustments to t he new environment of disinfla tion. I am convinced that if policymakers wi ll address this i ssue promptly, an extended period of noninflationary growt h lies just over the horizon.

J. Roger Guffey (1984, November 12). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19841113_j_roger_guffey

@misc{wtfs_regional_speeche_19841113_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1984},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19841113_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}