Regional President Speech

, The Prospects for Balanced Noninflationary Growth u.s. in the Economy Presentation to Denver Rotary Club Roger Guffey August 29, 1985 .. I I. Introduction Your kind invitation to meet with the Denver Rotary Club ~ I "­ today was indeed welcome. We at the Federal Reserve appreciate the opportunity to discuss the economic outlook and economic policy issues with bus iness and professional people in Denver and elsewhere. tie .j~e /s S e T -leY In my view, economic policy is now at a crossroads .A ~7~J ... ~~/~ .. a clash between monetary and fiscal policies that needs to be ~ (1Iftti#;;f- IN'--r ..II Reserve's~~iCYh~~~~~~ resolved as soon as possible. The Federal . 4-I~ remains one of restraining growth of money and credit to prevent -4t1.r.z:;;. ~ ~. infla~o1\ a resurgence of But this restraint has run up against the massive credit demands of the federal government to finance 1r- the budget deficit. ( _~ ~ ~ Evidence of this clash is painfu~ly apparent igh~interest ~.J~ , rates1 a growing trade deficit, an~lmbalances in our economy. As a result of these imbalances, the health of agriculture and other important sectors has continued to worsen, and growth in the overall economy has slowed noticeably, ~~i~~~ Because of the high stakes involved, the economic policy Ck4- ,..?1~ choices we makeAin the next few years to resolve these imbalances will determine our prospects for lasting prosperity. But if we th~at adopt policies the symptoms of our economic problems . It. ~~;9J;y rather than the root causes, we could impair the efficiency of our economy id)/'f"t!~ T ~ Before discussing my views on the most desirable course for economic me first review past policy mistakes in offsetting the effects of those mistakes in recent years. -2­ II. Past Policy Mistakes ~ The nat~n~mad~ in~ biggest policy mistake we as a ~ Aj accelerate Ain~1970s past 20 years was allowing inflation to . ......../1 I-+~~ In retrospect, it is clear that the most damaging effect of accelerating inflation was the changes it brought about in ~ericans ~to attitudes. think of high inflation as a natural part of economic life, and their behavior changed accordingly. We began to count on inflation to bail us out of business and investment ba~ decisipn~. ~ ClfIZd 'f"'~ During that period, polici:31to combat inflation were ~ ineffective--either because the policies themselves were flawed or because they were abandoned prematurely. The flawed policies Ua ... ~ c:v.l-­ includ~direc~overnment controls on wages, prices, and credit. ~~, We confirmed what we already should have known~¥~c~ legislate low inflation. Those policies that ~ld have been effective--fiscal and monetary discipline--were not pressed long enough to turn the tide, so inflation continued on an upward spiral. As the 1970s drew to a close, the costs of inflation were o.t( 7;" (!,).e,q.~, becoming mesQ .,pa~eH~. A declining dollar, low productivity growth, and erosion of business profits taught us that the economy doesn't work very well without a stable price level. There was also recognition that quick and painless solutions to the inflation problem were not possible, and that failure to face ~k. up to would ultimately entail much higher costs. the~ Against this background& f ~ n~~ ~'4e~ ~~'s...i:.~lY~~ ~~ the Federal Reserve announced in october 1979 a new -3­ program to ensure greater price stability. The centerpiece of the new program was a renewed commitment to restrain... the growth of money and credit. Through better control over the money supply, it was felt, we could help reverse the trend upw~rd I~ retrospect,~ I;~ in actual "and expected inflation. .. of GditJ'~d P" ----t.& ~ ~ ".'4' CL monetary restrain~has indeed been successful in reducing inflation from the double-digit rates of the late 1970s. And,~~s ~ o:::r.ell t)_r~""lLz- ~ a result, the problem of accelerating inflati~is .-elF- largely behind us. III. Effects of Monetary-Fiscal Imbalance Unfortunately, this problem has been replaced by a new set of economic strains and imbalances. Interest-sensitive industries have had only a m9dest recovery from the 1981-82 recession--because interest rates have come down much slower than inflation. Moreover, our export and import-competing industries have fared even worse because of the extraordinary strength of ltJ. theA,dollar. Some blame the strong dollar, high interest rates, and most of the economy's other problems on overly restrictive monetary pOlicy. A few members of Congress, for instance, accuse the Federal Res~~ting the economy on a credit diet that will ~ starve certa~sectors. ~tj..J-"(J~ /~ C\.. Eit 'a look at the factsf Traditionally, tota l credit has grown at a rate about equal to nominal GNP growth. Throughout this economic expansion, however, credit has actually grown ~ faster than nominal GNP. Indeed, last year, credit growth was ~ the highest in 40 years. This could hardly be described as~undue restraint on credit supplies. -4­ Instead,~interest rates have remained high because of an explosion in credit demands. Private credit demands have strengthened substantially over the past 2 1/2 years, as is normal during a period of economic expansion. What is not normal, though, is the continued heavy borrowing by the federal government. Historically, the fad ;ra;l deficit shrinks rapidly as 71t ~ . ~ . tth t ax revenues grow durlngAan edon mlC expansl0n. In contras, e ~1q:. . $" t . federal~deflclt has remalned near 200 bllllon throughout hlS recovery. As a result, the government must raise as much as $4 .... d~ . . bllll0nAof new money week ln and week out ln our money and capital markets. akLJ ~ ~~~ Exchange markets, ~, are affected b~fiscal developments . . ~ . Hlgh lnterest rates ln the united States--caused by large budget A deficits--forced up the exchange value of the dollar to record highs earlier this year. While the dollar has declined somewhat in recent months, it remains at such a high level t~at we~~:~ _/ ~ Utz ; "t..n ~ bound to continue experiencing massive trade deficits~ In essence, therefore, our trade deficit is the mirror image of the budget deficit. And, the growing trade deficit could have long- lasting implications, because the lon~r our exports remaiIl-... . pdL.- ItS ~ -l.-U4A. depressed, the more difficult it will beAto maintain~ting -fii ~ networks an~ recover~foreign sales. IV. Policies That Treat Symptoms "1l.e- The need to reduce trade deficit is clear. But in ~ striving to do so, there is a danger that Congress will adopt policies that we will all come to regret. -5­ One such policy is for Congress to impose increased barriers to free international trade. For example, a proposal currently 1:';t receiving serious consideration is an across-the-board increase 4 ~ fJfll ~ in tariffs goods. Another is discriminatory tariffs o~imported -r;; ~ ~ Japanese goods. Some argue that' ; e tariffs would not only lower the tr~d~deficit--by ~ing the attractiveness of ~~oX~ . (.j­ foreign goodS~bae would also help lower the budget deficit by increasing government r~venues. ~ ~~~ lAb~~ . BU~~ such a painless solution to our twin deficits really~ possible? I don't believe so. By raising the cost of imported ~ Z~ redUCing~petition by~stiC and faced producers, higher tariffs would raise the inflation rate, which we have paid .~ .,4..iI'\ so heavily to bring down. Moreover, ~::~ring the trade deficit ~",.I&o\,../ IDAlJ. 1ii ~. woul~reduce the inflow o~ f~~al~ And, that would ~~~ess cre~-.t result in the private sector and even higher ~ k ,4U"~"" !-J interest ration the limited supply of domestic credit. rate~to To be sure, some do~e~tic industries--such as the auto industry-­ ' M" ~~~~ ~,yr benefitAby higher tariffs. But they would do so at the ~~ expense of higher interest rates and inflation that would,reduce the long-run growth prospects for the economy a A~ whol~. ~ ~~~~ ~ fUll-~n Increased trade barriers also/ i nzi-te a trade war. If higher tariff barriers are adopted by the united states, other countries would almojt certainly follow suit by ~7/:Q ~S . . taking actions to restrict their As a result, u.s. lmport~ agriculture and other industries that rely heavily on exports ~ would suffer. -6­ ~-r:li ~~.~ 8imil&¥I1' , attempting to bring down interest and exc1!ange v_- ~ ~t.IC.~, ~ ~ ~ ~ Gl... rates ~expansionary monetary policy would be self-defeating~ By feeding concerns about inflation, excessive monetary growth would likely raise rather than lower interest rates, especially long-term 'rates. Moreover, a depreciation of the dollar caused by inflationary policies would not, in the end, help our exporters because that depreciation would be ac~ompanied by ° ra"'­ inflated domestic costs. We then would have~fueled the fires of inflation without having improved our trade balance. In evaluating policies to achieve balanced economic growth, we should keep in mind two basic lessons from the experience of the 1970s. The first is that we cannot achieve lasting prosperity by inflationary growth of money and credit. The dL«S or second is that gimmick~don't work. Trade barriers and similar policies only obscure underlying econom.ic problems. The . ~ ~~~~4~_oe~~ fundamental problem is that we as a natlon ar~consuming more than we produce. As a result, we face imbalances both in our !3 government budget and l · n our l . n t erna t l . onal tra d e RQ A a .. l(t!r3tDe n"I.f ! v. The Need For Fiscal Restraint What then can we do to resolve our internal and external imbalances? The only answer, it seems to me, is to make~er .f~ progress in reducing the federal budget deficit. Thel\spending cuts in the recently approved budget resolution are a useful first step toward fiscal discipline. H~r,~n if a~e~~~~1 . . . ~ . ~ approprlatlons process, wl11Aleave ~he thes~cuts th~deflclt at levels that would have been unthinkable a few years ago--and that should be unacceptable now. without further cuts in -7­ government spending or increases in tax the budget revenue~ deficit will remain high enough to keep interest rates and ~.a. exchange rate~ ~ ab ove levels that are consistent with balanced econn~A:~~t~ d ......iiiTi& I"( Dl\that Congress and the Administration simply must find ways to reduce the deficit further, even if doing so requires politically unpopular actions. On the fiscal side, then, the next few years will be a time in which very hard choices must be made. VI. The Fed~ral fteserve~s contribution Ci-d .:J -~=* CII.r&J ~~ 1':4 •• easy money is no sUbstitute fo~hard choices. Money creation by the Federal Reserve cannot replace fiscal discipline as a basis for restoring a healthy balance to our economy. Rather, the greatest contribution the Federal Reserve can make to lasting prosperity is to foster the expectation--and the reality--of reasonable price stability. This commitment to price stability doesn't that the me~n ~~<e_Q Federal Reserve should adhere rigidly ~money growth targets in all cases. For example w~en we initially set money growth l ~.e".,b.J__ ~ ranges for th~year(1n February, we thought that our target for the basic money supply, MI, was consistent with sustainable and noninflationary economic growth. However, because of an unexpected decline in monetary velocity--the rate at which money turns over, it became apparent that higher MI growth would be required this year to support continued economic expansion. As a resu~t,~ colleagues and I on the FOMC dec~~ to accept higher ft'y ~ '1~(JI,V a ~fe.-. ~ l.~ CIooQ.. MI growth~ Moreover, at our meetin~ ~6b ) we adjusted the ~(, · ~ -8­ 1Jl..k' Ml target range in a waYAI,believe will further contribute to . ~lI-rl continued However, I want to stress that our economlc ,~. accommodation of relatively high Ml growth this year should not be misinterpreted as a departure from our commitment to keep inflation·down.~ ~~ ~ What does thi~pOlicy imply for ~co~tloOk? with dt. oA . .. regard to the short-run outlook, I ln lnterest tbt-~ th~ldecllnes rates and exchange rates accompanying our relatively accommodative monetary POlicYlove~~h! ,as§\seVer~ m~will ., lead to some pickup in economic growth in the second half of the ~ A~~_ i~spending remain~dera~e ~ year. I expect that growth will u.s. that more of this spending will be on goods, thereby boosting growth in domestic production. run outlook, however, depends on whether the ~e. 1QP~r ::u.;t­ .~c>Z ~ ~~ imbalancesA~ are now sapping the strength from our economy are corrected. Federal Reserve monetary pOlicy, cannot by itself correct these imbalances. All we can do is to try to achieve reasonable price stability, which is the necessary foundation for sustainable economic growth. Moreover, the economy's imbalances cannot be remedied by artificial trade barriers. Indeed, protectionism would ultimately make the distortions even worse. In my view, relief for the sectors adversely affected by high interest and exchange rates can only come from a more responsible fiscal pOlicy. In this regard, I remain optimistic that further progress can be made in reducing the federal budget deficits that are mortgaging the nation's economic future. The recently passed .. ( n;:- '1~ ~ /-n j ,,;-f --f f-. ­ ~~spending ~~d cutsAsuggest that a new consensus on the part of Congress, the President, and the American people for meaningful deficit reduction. Only by building on this consensus can we make further progress toward bringing down interest rat es, exchange and trade deficits over time. r~tes, VII. Conclusion In summary, thenl1.. the American people and 'a1I.a. elected representatives face politically difficult choices in the years ah~ad. However, we must not allow th~~~itical difficulties postPoning~needed to serve as an excuse for fiscal discipline. Many otherwise healthy industries--including several in ~ Colorado--cannot hang on much longer. I know that we as a~' F~e a~:~gh adO~~ary are courageous to and fiscal policies that will work together to achieve a lasting prosperity. And, given the impo~f this effort--in terms of both our ~ domestic economy an~the world economy--we simply cannot afford to fail.

J. Roger Guffey (1985, August 28). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19850829_j_roger_guffey

@misc{wtfs_regional_speeche_19850829_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1985},
  month = {Aug},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19850829_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}