Regional President Speech

.. ,. ~/-~~~~ ~~//'/s /~ Thank you for the invitation to meet with you t his morning. As many of you know, we at the Federal Reserve Bank of Kansas City appreciate the opportunity to discuss matters of mutual interes t with representatives of t his region's vital small business communi ty. We have enjoyed productive discussions for a number of years. Many of you will recall that back in 1979 t hings were pa r ticulary difficult for t he nation's economy and for people operating small businesses. Rapid inflation was conti nuing at double digit levels and interest rates were in the 20 per cent range. During t his period--and into 1980, 1981 and 1982--we met regul arly with representatives of Small Business United to discuss t he role of Federal Reserve policy in our economy ana to gain a better insight into economic developments and, the impact of economic pol ici es on small businesses. As many of you know, this first effort to exchange information between small business and the Reserve spread Fe(~eral to other areas of the country and other Reserve Banks. Finally, planted in Kansas City through the etfort s ot Ron Piercy, Mike Milvai n, Jim Kirk and others, led to the establishment early this year of small business advi sory councils at all 12 Federal Reserve Banks. I must tell you that we are pleased that Ron Piercy has agreed to serve as one ot t he ni ne members of our council, which is made up of persons in small business and agriculture from t hroughout our seven-state region. The council' s first formal meet i ng was held about a month ago. -2­ I feel we have come a long way together. We in t he Fed have confirmed our understanding of the i mportant role of small business in the economy . And we hope many small business people better understand the Federal Reserve's objecti ves and the pol icie s a~d t ools we have available to ach ieve those oDjectives. I believe we have come to understand together tha t t he economic objectives of business and t he Federal Reserve are essentiall y t he same. In considering t he economic objecti ves we share , let me turn now and focus on t his morning's subject. My message includes a view that the nation's economy--de spi te some uneven performance -­ is in relatively good shape now, but that t here are fundamental problems that demand the attention of policymakers. How those problems are addressed will largely determine the nation's economic f ut ure. Let's look first at t he cur rent situation. As you know, the currnt economic expa nsion has continued for two and a half years. As you also know, this expansion has been oucstanding in many respects. Spurred initially by a drop in the rate of i nf lation, and t hen urged on by the de cline in short-term interest ra tes t hat be gan in 1982, economic growt h was remarkably strong in 1983 a nd through the first half of 1984. Even though the pace of economic growt h slowed somewha t beginning in the third quarter l ast year--a development to oe expe cted as t he expansion matured- -this par ticular period of u.S. busi ness growth has been the strongest since t he Korean War. -3­ Economi c expansion over this period has been aided by relatively favorable level s of interest rates. Though both nominal and real interest rates are still very high by historic standar s, consumers and businesses nonethel ess have been encouraged t o borr ow to expand their purchases of goods and services. strong credit dema nd caused short-te rm interest rates to trend upwards t hrough much of 1983 and 1984, but these rates dropped sharply last fall when business growth slowed. Reacti g to these declines and, to an ext e nt, facilitating them, t he Federal Reserve reduced the discount rate t o 8 per cent in December, and to 7 1/ 2 pe r cent just two weeks ago, t he l owest level since 1978. Al l in all, the past two years or so ot economic growth have provided compelling evidence of our economy's breadth and power. In particular, we can t ake pride that more t han 7 mi llion j obs have already been created duri ng t he expan sion. And we can point to many other positive developments, such as capital i nvestment-­ whi ch is up more than 30 per cent in real terms over the pe riod. But most of all, we are pleased that the contidence ot consumers and businesses has been restored af t er a dismal per i od of economic stagnation and recession. That period which preceded the cur rent expansion included the most devastating recession since the depression of the 1930's. So t he renewed PUblic confi dence is a hard-won victory. / A major reason for the restoration of confidence in the nation's economic future is, in my j udgement, the absence of excessive infl ationary pressures. Now, even arter a period of -4­ fairly rapid economic growth, infl a tion rema i ns a rel atively moderate 4 per cent or so on an annual basis. As you would expect--given the Federal Reserve's commi t ment t o anti-inflation policies--we are gratified at the progress made so far buc che is not yet won. battl~ De spite the undeniable benef its to our economy of more moderate i nf l ation and lower interest rates, a number of problems rema in to be addressed before we can feel fully opt i mist 1c abouc the longer-term health of our economy. Many of t hese probl ems are related to ad justments required in moving from a period of rapi d i nfl ation and high inflationary expectations t o a period with a more moderate inflationary outlook. As you know, many decisions made earli er i n anticipat ion of ongoing inflation continue to pl ague busi nesses and financial i ns titut 10ns during the current per i od of di sinflation. The consequences of those ea rlier inflat i on-biased decisions often are not easily managed and, taken together, compl icate the search for solutions to our economic problems . Agai nst that background of strong busi ness growth ana moderate inflat i on, I would l ike to consider with you briefly t he outlook for t he na tion's economy. Before giving you my impreBsions of the near-term prospects for continued business growth, I want to examine the potent i al for the nation's long­ term economic health. In so doing, I want to note s ome problems which, in my view, remain barr iers in the path of sustainable noninflationa ry growt h that we seek. These problems, which include the na tion's internat i onal trade def icit, the strains -5­ affecting our f i nanc ial institutions, and the federal budget deficit s, are all interrelated. One problem is the strength of the u.s. doll ar in inter nat ional currency markets resulting from our relat 1vely high interest ra tes and our favorable business situation. with the dol lar so strong, u.s. exports have been weak as domestic producers have been priced out of world markets . Over all, t he poor performance of the export sector has caused the current business expansion to be very unbalance d. Our own region, in particular, has suffe r ed because agricultural proQucers have lost ma ny export sales. Other sectors serving agricult ure have been robbed of potential growth. At the same time, the flooa of imported goods priced in weaker currencies has contributed to the se r i ous imbalance i n our trade position, wh i le steal1ng sales f rom our domestic busi nesses. To be sur e , a strong dollar has brought our economy some temporary benefits. For exampl e, the i nflow of foreign capit al has helped in the short run to finance both the business expansion and t he federal budget deficit. Another benefit i s that the ava i labil i t y of abundant foreign capi t al has kept our interest rates l ower than they otherwise mi ght have been. But these so-called benefit s have certain side effects. Some observers have pointed out that the United state s i s rapidly becoming a debtor nation, an unf amiliar situation, inaeea, for the richest nat i on in the world. When the in ternational value of t he dollar eventually ( declines, which i t will, the conseq uences of that decline will -6­ present mixed bles sings, at best. On the positi ve side, a lower dollar would certai nly improve the competitive position of U.S. goods in world markets and boost our lagging export sector. However, a fall i ng dollar could put upward pressure on domestic inter~st rates--as foreign capital moves elsewhere. Moreover, a declining dollar will lead to some i nflationary pressures as foreign goods become more cost ly and as domesti c businesses l ose some compet itive price discipline. In any case, the strength of t he dollar has been a problem and a decline in its val ue may wel l have negative consequences. _____·tion to the trade def icit and strength ot t he doll ar, ~~ a second problem is the continuing strains affecti ng our financial i ns titutions. One highl y vlsible aspect of t his problem is the inability of many lesser developed countr ies to repay on time or even service their huge debt s in the face of / worldwide recession and disinf lation. This situation has raised questions about t he earnings and capital positions of many of the world's major banks. Fortunately, it appears that l ower interest rates, rest ructured loan agreement s , and worldwide economic growth have begun to ease SOme of the pressure. Nevert hel ess, resol ution of t he problem wi ll require considerable time ana i~s effects will add a precautionary flavor to the out look for years to come. Though the international debt crisis dominated many of the headlines over the last two years or so, financial inst i t ut ions have been beset by domesti c troubles, as well. An extendea period of high i nterest rates--caused, in my view, by t he federal -7­ budget deficits--has created continui ng difficulties for ma ny business firms, particularly in agriculture ana energy. These problems, in turn, have been felt by financial institutions struggling to help finance the economic expans ion. Financia~ deregUlation has also contributed to the problems of f inancial institutions. Weakened thrift inst i tutIons and bank failures-­ 36 79 last year and about so far in 1985--are symptoms of these problems. So, too, are the troubles of Continental IllinOIs ana, to some extent, the Ohio and Maryland thri ft institut ions in ... recent mont hs. A thi rd--and the most t r oubling and pervasive--proolem cloudi ng the long-term economic outlook is the current and prospective fede r al budget deficits. I don't plan on "preaching to the choir" t his morni ng because I know that most of you here share the conviction that continuing massive budget det icits represents a serious hazard to economic progress. Small business re presentatives have been quite vocal in expressing their conce rns about t he perils of the deficits and I know that that ~ ~ ~ many of yo have written or visited with your elected re presentati ves i n Washi ngton about this issue. Many of us beli eve t hat the government's borrowing to fina nce the deficit s wil l ultimately collide with the private s e ctor's need for credit to fund continued growth. When both public a nd private credit demands are growing, the l ikelihood of rising i nt erest rates increases, as well. Aside from thei r costly impa ct on business, r i si ng interes t rates could rai se public fears about renewed i nflation. And high inflatIona ry -8­ expectations would surel y weaken the foundation of growth w1t h lower i nflation which has been laid. I do want t o emphasize my beliet that reducing--and eventuall y eliminati ng--budget deficits would remove a persistent thorn ~rom' the side of the nation's economic potential . ! Does anyone not believe that real deficit reduct i ons WOUl~ r educe real interest rates and diminish the inflat10nary fears \ generated by such mas sive deficits? such a result surely would hel p rel ax u ard pressure on t he lar and permit u.s. export s ~o ... to compet e more effectively in world ma rketsJ If t he dollar's relative val ue could be reduced gr adually, a series of orderl y adjustments in int ernational f inancial and commodity ma rkets could take place. Furthermore, if deficit reduct10ns ease int erest rate pressur es, our financial institutions coul d I - ant i ci pate fUrther relief from the st rai ns I described earlier. In t he f inal analysis, meaningful defici t-reduct ion action is an absolutel y necessary step in resolving the problems cloudi ng t he long-term outlook. Moreover, in my judgement, such a program is essenti al for the ultimat e economic health of t he nation. Thus , we all are wa tching the current budget debates in Washingt on with considerable concern. Let us hope that tne 1Jz.,.;. ~ 4~~"" ~ current discussionsj\w 1 indeed, lead to a strong first step toward a real political commitment for def icit reduction. Now let me turn to a brief discussion of the economic outlook for 1985. On this count, I continue to be general ly opt i mis tlc that moderate and sus tainable economic growth with relatively l ow inflation can be achieved this year. I say this because recent -9­ devel opments appear to have set the stage for such an out come, even though some observers now are questioning the staying power of the business expansion. / For one thing, short-term interest rates have come down sharply over t he past 10 months or so and remain well below last summer 1s peaks, primarily because credit demands have lessened as the economy shifted from rapid growth to a more sustainable pace. But I believe that these lower levels of interest rates also reflect optimism about inflation. Downward pressure on oil prices and continuing moder ation in wages and commodi ty prices are helping to reinforce reduced inflat ionary expectat ions and to preserve real income gains. Given this posit1ve tone, I believe that households and businesses will be encouraged to continue to lead the expansion. Though economic data are showing some m1xed signals, continuing strength is evident in spending for construction and other capital i tems, in factory orders, and in overall consumer spending, including sales of new homes and automobiles. However, the manufacturing and export sectors remain quite weak and capital spending appears to be sl owing rather abruptly this year. These developments and t heir effect on the OUtlOOK are st1ll generally in line with economic projections ma6e in February by members of t he Federal Open Market Committee. My colleagues ana I collect i vely expect ed real GNP growth thi s year in t he 3 t o 4 per cent range, with prices rising perhaps 3 1/2 to 4 per cent. a~ WeAexpect unemployment in the fourth quarter of 1985 t o average about 6 1/2 t o 7 percent. -10­ As always, a key factor in the economic outl ook for 1985 is the role that monetary policy will play. As most would agree, monetary policy has earned considerable credibility in t he financial markets and among the American public because of the Federal Reserve's consistent adherence to a f irm anti- inflationary policy. This policy is generally credited for much ~~~ of the success to date in bringing infl a tion underAcontrol. Thus, it wi ll not surprise you much when I say that, for 1985, the Federal Re serve remains comroitted to providing money and credit to the economy at a pace which will support s ustainable business expansion while, at the same t 1me, maintain1ng progress toward price stability. I should point out that the tentative growth rate ranges for t he monetary aggregates announcea i n February again reaffirm our stated intention to reduce, over time, the growth of money and credit. With continued moderate economic growth and typical demand for money and credit, we would expect interest rates to rema in relat ively stable over the upcoming period. Many financial market observers believe that the Federal Reserve's recent discount rate action will complement a general move to lower short-term rates in corning weeks. What the Federal Reserve seeks over the long run, of course, is for interest rates t o corne down and stay down so that greater investment and continued growth will be encouraged. In the short run, however, given the Federal Rese rve's commitment to a policy of moderate growth in money and credit, and given no resolution of the deficit issue, a return to very rapid economic growth would again undoubtedly put upward pressure on interest rates. · . -11­ In summary, the economy has grown steadily over the past two and a half years, and it should continue t o expand through 1985. The pace of expansi on t hi s year wll1 be somewhat more moderat e t han the earlier rapid growth, but that is t o be expect ed in a maturing expansion. Over the longer term, however , the ultimate health of the economy depends on meaningful reductions in the huge f ederal budget deficits. Such reductions would help i mportantly to bring about orderly domestic and international adjustments to t he new environment of disinflatlon. I am convinced that if our e lected officials will seriously addre s s t his issue we can look forward to continued progress for t he

J. Roger Guffey (1985, May 29). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19850530_j_roger_guffey

@misc{wtfs_regional_speeche_19850530_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1985},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19850530_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}