Regional President Speech

By Michael E. Levy with Steven R. Malin, Delos R. Smith and Gerd-Ulf Krueger Economic Policy Research The Conference Board 1985, No.1 Monetary Policy In 1985: Extending The 1984 Criteria Last year's economic performance greatly ex­ ceeded even the most optimistic forecasts. Real As in former year • the rust report in the 1985 senes growth averaged 6.8 percent, the best showing of Economic Policy Issues is devoted to analysi of since 1951, while Inflation (as measured bV Implicit monetary policy. To broaden the perspective ofour 0","'Tl analysis, we again asked the President of a Federal GNP deflator) rose only 3.7 percent, the smallest Reserve Bank and three private- ector economists of Increase since 1967. The dollar showed extraor­ different persuasions to provide brief asse ' menLS of dinary strength throughout most of 1984; surpris.­ last year's Federal Reserve policy and near-term Ingly, It rose to a new high toward year' end as prospects. Their contributions are gratefully the Fed eased monetary policy and U.S. Interest acknowledged . rates declined sharply. (Declining U.S. Interest Roger Guffey, President ofthe Federal Reserve Bank rates had been expected to result In an easing of of Kansas City, stre ses that promoting sustainable the value of the dollar.) growth is a prime goal of the Fed and preservation of price stability i its main contribution to this goal (pag Despite last year's impressive economic perfor­ 2-5). Michael Keran. Vice Pre ident and Chief mance (which Included a decline In the unemploy­ Economist of the Prudential Insurance Company of ment rate to 7.1 percent), there remained three America, and Ben E. Laden. Vice President and Chief problems that carry over Into 1985: (1) A severely Economist at T. Rowe Price Associates, Inc., assess Fed depressed farm sector and a system of small policy in 1984 and the propect~ for 1985 (page 8-10). banks In the farm belt that remains precariously Peter I. Berman, Second Vice President/Inve tments exposed. (2) A record U.S. trade deficit of $123.3 with International Gold Corporation Ltd., consider billion In 19B4-lnduced mainly by rapid U.S. economic implication and policy responses to a decline growth and the strong dollar. (3) Persistent huge in the dollar (pages 11-(2) Steven R. Malin wrote our own analysis for this federal budget deficits despite the economic pros­ report. perity. Reducing the federal budget deficit pro­ Our £PI eries is available to our Associates upon bably will be the most Important economic policy written request to The Conference Board. Annual Is ue confronting President Reagan and the 99th "public ervice subscriptions" are available for full­ Congress during the current year. time educators and civil servants. The main goals of monetary policy In Michael E. Levy, Director 1984-su ltainable real growth and preservation Economic Policy Research of price stability-are likely to contlnue February 20, 1985 dominating Federal Reserve policy In 1985. (See © 1985 The Conference Board, Inc. .... below for Roger Guffey's assessment.) The Fed When It became apparent that real growth was appears to respond now with a lag of several slowing drastically during thethird quarter of1984 months to large swings in the real economy. while the money supply flattened out, the Fed Specifically, unsustainably rapid real growth trig­ responded with several moves toward monetary gers monetary restraint, whereas a sharp easing. Thus, a decline in interest rates triggered slowdown ineconomic growth induces eaSing by by the economic slowdown was quickly reinforced the Fed. Money growth'lates and the Federal by an easier Federal Reserve policy. (In this con­ Reserve's target ranges have come to serve mere­ nection, see Michael Keran's analysis In this ly as a "secondaryguideline" formonetary policy, report.) while international considerations received In 1985, the Federal Reserve is likely to adhere relatively little special attention last year. to the same policy approach as in 1984. As long Thus, In response to the extraordInarily rapid as economic growth proceeds at a moderate and real growth (10.1 percent) during the first quarter sustainable pace, the Fed will continue to accom­ of 1984, the Fed let market pressures drive up in­ modate the economic expansion at relatively terest rates. Only when unsustainably vigorous stable(oreven declining) Interest rates. Once the growth continued through the second quarter (7.1 economy gathers momentum, the Fed Initially will percent) and rapid money growth threatened to permit market forces to raise Interest rates. Only push the money supply above the Fed's target Ifthe paceofreal growth threatens to become un­ range,--dld monetary polley shift more forcefully sustalnably strong Is the Fed likely to sh1fttoward toward restraint. As a result, Interest rates active monetary restraint (driving Interest rates escalated further until midyear. higher in the process). THE FEDERAL RESERVE'S ROLE IN PROMOTING ECONOMIC GROWTH by Roger Guffey' Each policy direclive of lht Fc..>deral Open Market Rl' crvc' role in promoling economic grov,1h isa limi cd Committee (FOMC) contains a tatemenl of the goals but important one. It is limited becau 'e many aCl r ofFederal Reserve monetary p !icy. One of(ho e goal~ out 'ide the conlrol of monetary policy influence is t "promote growl h in outpul on a sustainable basis.•, economic growth. It is nonethel ' imp rtant becau e It ha'i long been recognized that only through ustained the economy cannot realize ie growth" (enlial WIthout economic growth can we improve living landards, in­ rca onable pril.:t: stability, which ib largely \\ ithin tlle creasejob opportunitie •and help LO acbie e other na­ conlrol of monetary p licy, In m_ view. r her for • the tional economic priorities. 1n addilion. several ofour major contribution that monetary polie. can mak~ to current economic problcms- UCD a the international su tained economic growth V, to en ur~ reasonable price debt situation, the lederal budget deficit, and Ihe finan­ stability. cial Ire s in agriculture and other imponant eclor­ Nor all would agree ~ith th S3ssessment. orne have or can best be managed in all environmenL economi argued, for ampl!:. Ihat monctar pohcy can and growth. For all these rea ons, therefore. I believe su.­ hou!c.l promote growth by keeping itnere t rate 10 . twned economic growth !)itould be Ihe pn.'eminenl long­ They reason lh l low imeresl rate. n ourage "apltal run goal of e anomic policy. inve lmenl, lhus raising productivity and e anomie What can the Federal Reserve contribute to achie ­ growth. ing this goal? It should be reeo nized that lhe Federal The flaw in thi:. argument i lh t capital investment depend. on real interest rates, which are affected by I Roger Gu/'tey is Pr~idc", I th~ Frocral Reerve !lank of monetary policy only in the vcry :hort run. It i Lrul! that Kan a City. The \ iew~e."J"lre:~ed In th article are the author's easy money and credit can temporarily depre marker anu nOl tht: \ i \\IS 01 the: federal Reser\'c Sy~tem, interest rale·. Ho ~ever, as soon a 'the inllationary con­ 2 Most economists proJect another year ofstrong, regard to U.S. interest rates. This would stimulate but sustainable, real growth (3.5to 4 percent) with world economic growth and assist debtservicing fairly stable prices for 1985. However, patterns of by the less-developed countries. In case ofa sharp quarterly volatility-rather than the average an­ drop in the value ofthe doliar, temporaryTreasury­ nual growth rate-are likelyto determine the Fed's Federal Reserve Intervention In the foreign ex­ policy responses in 1985 Just as they did in 1984. change markets appears a distinct possibility. Last year's forecasting record suggests that Finally, what furthercan be said concerning the economists are iii-equipped to predict these outlook for interest rates in 19851 The record of quarterly swings.. (Most economists projected the 1960's and 1970's reveals that the third year relatively slow growth early In 1984 to be followed ofany sustained economic expansion always pro­ by much faster growth during the second half of duced rising Interest rates, whereas second-year that year!) patterns were much more diverse. (See chart on In 1985, International considerations are again page 4.) Thus, historical patterns as well as the expected to exert relatively little Impact on Federal continUing high federal budget deficits suggest Reserve policy-except In the unlikely cases of an that strong real growth In 1985 should produce a International financial crisis ora sharp dropin the pattern of rising Interest rates later In the year. value of the dollar. (See Peter Berman's assess­ However, Improved inflationary expectations ment.) Yet, international conslderatlons­ could modify these historical patterns In 1985. The including a further weakening of011 prices-could unusually saw-tooth pattern of interest rates in Induce the Federal Reserve to Impart to its 1984-partlcularly the sharp declines after mid­ monetary policy a slight downward bias with year-indicatethat financial-market experts have cqucnc ar' r~alized. the innation premium ill nominal welcome the national d bate timulated by the Treasury rat ri 'CS pushing market Jal' up enough to r lor Department's recent ax prop sal. I a "Oat tax," or t real rat to their prcviou I d. a re ult, holding some ther tax sy"1 'm, would enhance incemiv ~ r market rat down b inflationary grow lb f m neyand economi growth, such a y tern hould be gi en serious credJl iII nol Limulnte in~'e tmenL Indeed, pa t onsideration. It w uld be unfortunate, h \ 'ever, if p ri nee uggesl lital by in -rcasin un ertamly. inna­ di I,;U Ion ofLa reform divert attemion from the mo t tion lead ultimately 10 hi h r nt re t rat and lo\\er pr sing fiscal i sue-the budget deficit. With the t k price. rhcr fore. J..: pin m. rke inlerest rates ederal Government ab. orbing up 10 one-third of artilidallylow c,al bestine fedu I ndatwo tcounter­ Pnvate ector aving·. too little IS left over for the pro­ pr dUCli c in achie in ustainablc econorrll growth. du ti inve lment nece sary to ustain ec nomic Theneed to focus on real ratherth,m n minal interesl growth. 1oreover. the hi h mlerc.~t rale a d troug rat dcmonslrat a more g neral principle-that d Il r that have accompanied large bud t d 'fieil economic growth i deLermmed primarily by real a ­ threaten Lo damage irr par bly orne omesill.: in­ tor rather than by redit condition. Th avmgs rate dustrie thaI ould othcrwi e contribul to economic d I rmin how much OUI put can be dev ted to in 1­ growth. Bringing down the budget defi it b the rna t ment; hanges in technology and con urn r preferenl,; important fi al policy clion that auld betaken to im­ m create profitable pportunitie forcapiL 1 inve nt' prove pro pe t for balanced and susHlillcd economic nd 111 estm nt increase produ tlvity gro th, hlch growth. i th driving fore behind sustain de paDsion in ouL­ Monetary polic ha a rol ,LOa. That role is to pro­ put. Th ere I fa [or. nol nomin I In(crest rate. are vide a table finan ial envir nmenL for C onomie deci­ the rund Imental deternlinant of «om mi ro th in Sion making. Such an em-ironment re Ulres Lability not y r th long run. only 01 the financiaJ tern bot a\. 0 the aggregal cvcrthck s, economi policy het a role 10 play in priceJevel.Rea nablc pricestability i neees aryto n­ promoLingeconomi gr wth.FiscaJ policy-th gO\ m· ur that th market system efficienLly 1I0c les real men,' taxing and . p nding eel, ion -afferu in en­ re ouree to the produl.!tivc s tor ofthe economy that live lor a ing nd inve tment. In thi' r garti. I drive economic growth. 3 Changes In Interest Rates During Economic Expansion P B o a i s n ta ts Bails P\)in!S ~r--------r-------'--------.--------' ~~------~-------,--------.--------. 3-Month Tre. .ury Bill. AAA Corporate Bond. 200 300 160 200 100 100 / 50 o ~~~'-}~-I--:::-------l¥~~---I February 1961 February 1965 -100 -50 -200 -100 ,e 6 12 18 24 30 36 42 6 12 Months "Iter Trough Months "fler Trough U S Trwa.utY.' MOocty'. InVMtOl ServP. The Conie'ttoc* Board reduced their Inflation expectations. Since real declines of both nominal and real interest rates U.S. Interest rates remain at hlstortcally high levels during 1985 cannot be ruled out. while Inflation continues to be subdued, further Michael E. Levy MONETARY POLICY CRITERIA, 1984-1985 Beginning In mid-1982, the Federal Reserve aban­ tially to relieve international and domestic financial doned its single-minded anti-inflationary policy in pressures that could seriously disrupt the economic favor of a more pragmatic approach, intended to recovery or price stability.) reduce interest rates, stimulate the economy, and Although 1983 ended with both the economic ex­ avoid domestic or International financial crises. (For pans on and disinflation well Intact, a continuing large a review of monetary policy In 1982 and 1983, see federal budget deficit. high real interest rates, and the Economic Polley Issues, 1984, No.1.) Under the Fed's large and growing international trade deficit made revised approach, as long as inflation remained under continuation of U.S. prosperity in 1984 and beyond control, policy decisions' 'would depend on evidence less assured, Massive Treasury financing in 1984 about the strength of the economic recovery, the (estimated at between $170 and $190 billion) was ex· outlook for prices and inflationary expectations, and pected to intensify normal cyclical pressures on emerging conditions in the domestic and intemational nominal interest rates, and to raise real interest rates financial markets." (On two occasions-In the Spring beyond already historically high levels, Throughout and In the early Autumn of 1983-the Fed exercised 1983, large differentials between U.S. and foreign real Its new flexibility by initiating moderate, though time­ Interest rates had attracted record inflows of foreign ly, adjustments in monetary policy-first by increas­ capital into the United States that helped to moderate ing, and then relaxing, restraint in the provision of pressures on U.S. financial markets, raise the value reserves to the banking system. The purpose was par- of the dollar, and control inflation Yet a growing Ihreatened t inlensi y innationary pressur and pro­ ooking ahead to 1985, I beli ve t.he pproach to ducemon tarygrowth bovetheannounced arg' . In monetary pohcy hould be similar to that of the pa t r pon ,in rea d pr UTe applied on re rve )'ear. The announce rang for monetary rowth are p ition of depository j titution, and the eli aunt onsi t nt with continued ec noml nsi n Priv Ie tew in re ed. omecrui d cribedth r IriC­ foreca ler predi t r al GNP grO\ h of b UI 3.5 pcr­ tiv ti n being • anli- ro th.' fo lh contrary nt Lilli ye • Ba cd n e rien e la t year. I belie e su h action were de igned to • upport su tainable real th Federal Res I'Ve h uld be p pared to ac mtnodat.c growth by prevenun reace ler tion f innation. Ill' Uti or even hi her, real gro Ih so I ng a it i not deed, as geo 'th of mon yand 'pending lo ...ed after achi ved at the pri e of a hi h r Ir nd inflation r tc. midyear and i1 b cam apparent that inflationary We do not know how rapidly the economy can row pr sure w re bing contamed, til FOM re p nded in this third y ar 0 recovery without puttmg excess b reducing pres ure on Te erve po itlon and lowering demand. on labor and product market • We do know the dis unl r teo that allowin such .. demands to per ist Wllliead E onomlc development la t ear ere ver • eventually to higher actual and expected inflaLion that favorable. Nominal GNP ro h of about 9.5 per n1 would erod lh foundation r u ainable gr wth. It w in line with FOMe e: p lations and a aceom­ \\ ould be irresponsible for the ederaJ Reserve to pur­ pani d by growI}l of M-l and M-2 ne r the midpoints sue uch a myopic poli • of aJlowin e c demand of their range Becau e of f vorable upply- ide to per' t. We did nOl do 0' st. car nd should not de 'clopments-su h as d liuiu oil prices a tron do so this year. doll r, and continued moderation of labor cO s-thi In :\ummary. the nation ov rail onomi obj lives GNP growth w as ociated with mo rapid real growth can be t e achieved within a ramework ofsustainable and I innation than initially anti ipaled. It' grati­ economic growth. F r thi. reru on, b Ih mone aryand fying that larg r utpul and emplo) ment gat \ ere fis al poli i hould be aim d at achi ing this laudable po ible without producing incipient inrlalJ nary goal. The major contribution that monetary policy c n pressure that would ultimately undermine econ mi make to u!ttained economi grO\ th i to cn ure growth. rea 011 ble price stability. 5

J. Roger Guffey (1985, February 19). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19850220_j_roger_guffey

@misc{wtfs_regional_speeche_19850220_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1985},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19850220_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}