Regional President Speech

" , . THE ECONOMIC OUTLOOK: PROSPECTS AND PROBLEMS Remarks by Roger Guffey President, Federal Reserve Bank of Kansas City The Fourt h Annual Minority Business Development Age ncy Confer ence Kansas City, Missouri Septembe r 4 , 1985 > '" I. Introduction Thank you for your kind invitation to meet wi t h you today during your fo~u~~~~,nn~al MBDA Conference. I am pl eased that you have chosen to meet in Kansas City, a community where many people are commi t ted to minority business opportunity. I especially appreciate t h is chance to discuss the economic outlook and economic policy i s sues with people who understand t he role of sound economic policy in generating -r-e-a--l economic opportuniti es for all ki nds of businesses. ~ In my vi ew, economic policy is now at a cr ossroads. Th~ stage is set f or a cl ash between monetary and fiscal pol i c ies that needs t o be resolved as soon as poss i ble. The Federal Reserve 's monetary policy (that is, management of t he nation' s money and credi t ) remains one of res raini ng growth of money and credit to prevent a resurgence of inf l at ion and i nf lat ionary expectat ions . But t his restraint has run up agai nst the massive credit demands of t he f ederal government to finance the budget def i cit. ~, j d, 2' Sf~is clash is painfully apparent-- as evidenced by high real interest rates ya gr owing trade deficit , and serious imbalances in our economy. As a result of these imbalances, tne health of a~iculture and other important sectors has continued t o worsen, and growth in t he overal l economy has lowed noticeabl y over the pas t year or so. Because of t he high st akes inVOlved, the ec onomic policy choices we make as a nation i n the ne xt few ye ars to resolve t hese i mbal ances will determine our prospects for l a sting · .' -2­ prospe rity. But if we adopt policies that just treat the symptoms of our economic problems rather than the root causes, we could seriously impair the efficiency of our economy for years to corne and, in so do ing, limit the opportunities for the growth and prosp~rity sizes ~~~ of businesses of all kinds and ~"... ( Before discussing my vi ews on the most desirable course for economic policy in t he future, let me first review Pg st policy mistakes and the subst a ntial progress we have made in offsetting .. t he effects of t hose mistakes in recent years • II. Pa st Pol i cy Mistakes In my j udgement, the biggest policy mist ake we as a nation have made in the past 20 years was a l lowing inflation to accelerat e to doubl e digi t level s i n t he late 1970s. In retrospect, i t is clear that the most damaging effect of accelerating i nf lation was t he changes it brought about in~ att i tudes. Ameri cans began to t hi nk of high inflation as a natural par t of economic l ife, and their behavior changed accordingl y . We began to count on i nf l ation to bail us o ut of bad business and investment decis'o s. During that period, policies des igned to combat inflation were l argely ineffective-- either because the policies themselves were fl awed or because t hey were abandoned prematurely. The f l awed policies included such t hings as direct government controls on wages , prices, and credi t . We conf irmed what we a I,r eady should have known--that is--you cannoe l egislate l ow Those policies that mi ght othe rwise have been inflat~n . effective--f i scal and monet ary discipli ne-- we re not pressed long -3­ enough to turn the tide, so inflation continued on an upwa rd spiral. As the 1970s drew to a close, the costs of i nflation were becoming all too clear. A declining dollar, low productivity growth, and erosion of business profits taught us t ha t 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 up to the task would ultimately entail much higher costs. ~ Against this ba ckground, t he Federal Reser ve announced in Oct ober 1979 a new program t o ensur e greater pr i ce stabil i t y. The centerpiece of the new program was a renewed commitment to restrai n t he growth of money and credit. Thr ough better control ov er t he money supply, it was fel t, we could help reverse the upward t r end in actual and expected inflation. In retrospect, the Federal Reserve's policy of monet ary res t rai nt has indeed been s uccessful in reducing inflation from the double- digit rat es of the late 1970s. And, as a resul t, the problem of accelerating ~ l east for t he present is l ar gely behi nd us. inflatio~ at I II. Effects of Monetary-Fiscal Imbalance Unfortunately, this probl em has been replaced by a new set of economic stra ins and imbal a nces . Interest-sensitive industries have had only a modest recovery f rom t he 1981-82 recession--because int erest rates have come down much sl ower t han i nflation. Moreover, our export and import-cornpeti .g i ndustries have fared even worse because of the extraordi nary st rength of u.s. the dollar. -4­ Some blame the stron 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 Reserve of putting the economy on a credit diet that wi ll surely starve certain important sectors. However a look at the facts suggest otherwise. Traditionally, total credit has grown at a rate about equal to nominal GNP growth. Throughout this economic expansion, however, credit has act ua lly grown much faster than nominal GNP. Indeed, ~ l a st year, credit growth was the highest i n 40 years. This could har dly be descr i bed as an undue r estraint on credit s uppl ies. Ins t ead , real i nterest ra tes have remained high because of an explosion in credit demands. Private credit demands have strengthened substantial ly over the past 2 1/2 years, as is normal during a period of economi c expansion. What is not normal , though, is t he continued heavy borrowi ng by t he f eder al government . Historically, t he f ederal deficit shrinks rapidly as tax revenues grow during t he early phases of an economic expansi on. In cont rast, the feder al budget deficit has remained near $200 billion t hroughout this recovery. As a res ul t , the government must r aise as much as $4 pilli on dollars of new money week in and week out in our money and capital ma rkets. Foreign exchange ma rkets also are affected by these fiscal developments . High real i nter est rat es i n the Uni ted s tates -I caused by large budget def icits- for ced up the exchange value of the ol lar to record highs earl ier this year . While the dollar has declined somew at in recent months, it r emains at sUCh a high · " -5­ level that we are bound to continue experiencing massive trade deficits in the period ahead. In essence, t herefore, our trade deficit is the mirr or image of the budget deficit. And, the growing trade deficit could have long-lasting implications, because the l onger our exports remain depressed, the more difficult it will be for O.S. producers to maintain their overseas marketing ne tworks and to recover their foreign sales. IV. Policies That Tr ea t Symptoms The need t o r educe the trade deficit is clear. But in striving to do so, t here is a danger that Congr ess will adopt policies that we will al l corne t o r eg ret. One s uch policy i s for Cong ress to impos e increased barri ers to free international trade. For exampl e, a proposal currently receiving serious cons ideration is an across-the-board increas e i n t a r iffs on many imported goods. Another is discr i minatory tarif fs specifi cally directed t o J apanese goods. Some argue t hat s uch tarif fs would not only lower t he trade deficit - by reducing the attractiveness of f o rei gn goods--but t hat such tariff s would also help lower the budget deficit by incr easing government revenues. But one has to ask whet her such a pai nless sol ution to our twin defici t s real ly is possi bl e? I don' t believe so. By rai sing the cost of imported goods and r educing the competition faced by our domestic producers, higher t ariffs woul d raise tne i nflation rate, which we have paid so heavily t o bring down. Moreover, lowering the t r ade def i c it in this manner would tend to r educe t he inflow of capital from abroad. And, that would res ul t -6­ in even less credit being available to the private sector and even higher interest r a tes which would be necessary to ration the limited supply of domestic credit. To be sure, some domestic industries--such as the auto industry--might benefit in the short run by higher tariffs. But they would do so at the expense of higher interest rates and inflation that would over time reduce the long-run growth prospects for the economy as a whole. Increased trade barriers also would quite l ikely trigger a full-blown trade wa r . If higher tariff barriers are adopted by ~ the United stat es , ot her countries would almost ce rtainly follow suit by taking actions t o restrict thei r imports f rom the U.S. As a resul t, U. s. agricul ture and other i ndustries that r ely heavi l y on export s sales would s uffer . On t he other hand, attempting to bring down interest and exchange rates by followi ng a more expansi onary monetary policy woul d be self-def eati ng i n my view. By f eeding concerns about infl ation, excessive monet ary growt h would l ikely raise rather than lower i nterest rat es, es pecially long- term rates. Moreover, a depreci ation of the dollar caused by infl a t ionary polic ies would not, in the end, help our exporters because that depreciation would be a ccompanied by inflated domestic cost s. We then would have again f ueled t he f i res of inflation wi thout having i mproved our trade balance. In evaluating pol icies t o achieve balanced economic gr owth, we should keep i n mind t wo basic lessons f rom the experience of t he 19709. The f irst is that we cannot achi eve lasting pros per i ty by inflationary growth of money and credit. The -7­ second is that gimmicks just don't work. Trade barri e rs and similar policies only obscure underlying economic problems. The fundamental problem is that we as a nation are borrowing more than we save and are consuming more than we produce. As a result, we face imbalances both in our government budget and in our international trade accounts. 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 , i s to make further pr ogr ess i n reducing t he federal budget def icit. The proposed spending cut s in t he recent ly appr oved budget r e solution ar e a us eful f i rst step t oward fiscal disci pl ine. However , even if adhered t o in t he appropriations proce ss, these proposed cuts wil l st i ll leave t he project ed def ici t at l evels that wo uld ave be en unthinkabl e a few ye ars ago--and t hat shoul d be unaccept able now. Wi thout further cuts in government spendi ng or incr eases in t ax revenues in the years ahead , t he budget def icit will remai n high enough to ke ep interest rates and exchange rat es wel l above levels that are consistent wit h balanced economic growt h. I t herefore concl ude that Congress and the Administration simpl y must find ways to r educe t he deficit further , even i f doi ng so requires politically unpopul ar act i ons. On tne f i scal s i de, t he n, t he next few year s wil l be a t ime i n which very ha rd choices mus t be made . VI. The Federal Reserve' s Contribution -8­ As I indicated earlier, easy money is no substitute for those 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 gr eatest contribution the Federal Reserve can make to lasting prosperity is to foster the expectation--and the reality--of reasonable price stability. Th i s commitment to price stability doesn't mean that the Federal Reserve should adhere rigidly to some magical money growth targets in all cas es. For example, when we initially set ~ money gr owth ranges for t his calendar year back in Febr ua ry, we t hought t hat our t ar get f or t he basic money s upply, Ml , was consi s t ent with sus t a inable and noninfl at ionary economic growth. However, because of an unexpec ted decl i ne in monetary veloci ty-­ the rate at which money turns over, i t became apparent t hat higher Ml gr owth would be required this year t o support cont i nued economi c expansion. As a result , my colleagues and I on the FOMe decided to accept higher Ml growt h f or the year as a whole. Moreover, at our meeting in J uly, we adjusted the Ml target range in a way t hat I bel ieve will further contribute to cont inued economic expansion. Howev er, I want to stress that our accommodation of relativel y hi gh Ml growth this year shoul d not be misinterpreted as a departure from our commi tment to keep i nflat i on down. What does t his ki nd of monet ary policy imply for t ne economic out l ook? wi th regard t o the short-run out l ook , I believe the earlier declines i n interes t rat es and exchange rat es accompanyi ng our relat ively accommodative monetary pol i cy will -9­ lead to some pickup in economic growth in the second half of the year. I expect that growth in consumer s pending will remain relatively moderate but that more of this spending will be on u.s. goods, thereby boosting growth in domest ic production. The longer run outlook, however, depends on whether the imbalances t hat I have described and that 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, wnich , is t he necessary foundation f or sustainable economic growth. Moreover, t he economy's i mbalances cannot be r emedi ed by arti f i c ial t rade barriers. Indeed, protectionism would ultimately make the di stortions even worse. In my vi ew, relief for the sectors adversely affected by igh interest and exchange ra tes can only come f rom a more responsi ble fiscal policy_ In t his regard, I remain opt imisti c that furt her progress can be made i n reducing the federal bu get deficits t hat are mortgaging the nation's economic future. The recent ly passed proposed spending cuts for fiscal year 1986 and beyond s uggest t hat a new consensus may have emerged on the part of Congress, the President, and the American people for mea ningful deficit reduction. Onl y by buildi ng on thi s consensus can we make f urther progress toward bringi ng down interest r at e s, exchange rates , and t rade def i cits over time. VII. Concl usi on In s ummary, t hen, it seems to me that the American people and our elected repr esentatives f ace politi cally diffi cult -10­ choices in the years ahead. However, we must not allow these political difficulties to serve as an excuse for postponing further needed fiscal discipline. Many otherwise healthy industries cannot hang on much longer. I know that we as a nation are courageous and hopefully wise enough to adopt tnose monetary and fiscal polic i e s that will work together to achieve a lasting prosperity. And, given the importance of this effort--in terms of both our own domestic economy and indeed t he world economy--we simply cannot afford to fail. ,

J. Roger Guffey (1985, September 3). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19850904_j_roger_guffey

@misc{wtfs_regional_speeche_19850904_j_roger_guffey,
  author = {J. Roger Guffey},
  title = {Regional President Speech},
  year = {1985},
  month = {Sep},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19850904_j_roger_guffey},
  note = {Retrieved via When the Fed Speaks corpus}
}