Regional President Speech

THE ECONOMIC OUTLOOK FOR 1987 AND BEYOND Remarks by Robert P. Forrestal, President Federal Reserve Bank of Atlanta to the Atlanta North Chapter of the National Association of Accountants January 20,1987 Good evening! I am honored by this invitation to your first meeting of 1987. A the beginning of the new year individuals, organizations, and even whole societies revie’ both their achievements and shortcomings during the previous 12 months and look ahea to the coming year. January is not only the time of New Year's resolutions and annut reports but also of economic forecasts, and the outlook for the national and th southeastern economy will be the focus of my remarks here tonight. January is a bus time for accountants as well, and this January perhaps is exceptionally so because of th recent tax reform. I will have a few things to say during the course of my comment about that new law and its probable economic impact, though Fm sure that most of you i the audience are far more expert than I about the finer points of that legislation. I ma ask you a few things about that new tax code during the question and answer period. Last Year's Performance Most economic forecasts begin by looking at current and past performance. Ther are three basic measures commonly used to gauge how the nation is doing, economical] speaking—gross national product adjusted for prices (or real GNP), unemployment, an inflation. Last year GNP grew about 2 1/2 percent. That was close to par for oi nation's postwar performance, but with ample excess capacity in the nation the rise di not seem all that fast. The increase in GNP was sustained largely by consumer spending A strong housing market, especially early in the year, and incentives from auto maker provided considerable stimulus to demand. Despite the vitality of consumer spending other major components of GNP, particularly capital spending by businesses and ne exports, were weak, dampening growth. Given this relatively moderate pace o expansion, it has been difficult to nudge unemployment down to the more acceptable 6 t Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- 6 1/2 percent range from the 7 percent mark, where it remained lodged for most of tl year. Fortuntately, it did decline to 6.7 percent in the final month of 1986 though F reluctant to interpret one month as a trend. The measure by which we have done best is inflation. The consumer price index wi probably come in at something under 2 percent—better than almost anyone thought would. Wholesale prices actually declined. The low level of price increases was pleasant surprise attributable primarily to the drop in oil prices. After falling brief below $10 per barrel, oil prices settled in at around $14 to $15 per barrel, bringir respite from the inflationary tendencies fueled by higher energy costs in the recent past Forecast for 1987 Turning to the economic outlook for 1987, I foresee the expansion continuing t about the same pace as last year, that is around 2 1/2 percent. That rate of growth unlikely to bring about much reduction in unemployment, and so joblessness will probabl not fall too much further, if at all. However, inflation could inch back up to around 3 1 3 1/2 percent, more like its behavior in 1985 when it averaged 3.8 percent. Even thoug this sounds like more of the same, continued growth should bring with it greater balanc among the various sectors of the economy and regions of the country. The chief sources of support for this forecast are consumer spending, stabilization < energy prices, and, most importantly, the international sector. Though still a small pai of our economy, the international sector is really the peg on which expectations < economic growth are hung. The dollar’s high value on foreign exchange markets durir the early 1980s weakened U.S. exports of farm and manufactured goods and facilitate import penetration into domestic markets by foreign producers. This deterioration in oi trade position has exerted a tremendous drag on overall GNP growth—shaving as much f Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- a point or more off total GNP growth. It has also had a devastating effect on local are« whose economies are export-oriented or vulnerable to foreign competition. Fortunately, during the last two years the dollar has declined substantially again! the currencies of most of our major trading partners, though not against those of Canac and the newly industrializing countries of the Pacific. This depreciation in the dollar foreign exchange value has been raising the price of most foreign goods—with tl important exception of oil—relative to domestically produced items. It should, ov< time, provide U.S. manufacturers with stronger demand, from at home as well t abroad. A number of factors, including the sharp drop of oil prices and a subsequer surge in the volume of oil imports, delayed the adjustment of trade patterns to th currency realignment, but beginning last summer the trade deficit at last diminished f< three successive months. I believe the reversal in November will prove temporary and the trade deficit wi continue narrowing in 1987, thereby boosting demand for American farm ar manufactured goods and adding significant stimulus to GNP. Exports should increas moderately as prices of U.S. goods to foreigners become cheaper. However, tl weakness of certain other major advanced economies will probably temper th tendency. Imports seem likely at least to stabilize this year in view of rising prices f( most and the less volatile price of oil in recent months. This would also give a boost t hard-pressed U.S. producers. Consumer spending should be sustained by reasonably healthy wage and salat growth and personal tax cuts that will increase disposable income of many household Still, I don’t think we can count on the consumer as much as we have in the last few yeai to be the economy's chief expansionary force. Some consumer-financed consumptio Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- could be discouraged by the phase-out of deductions for interest charges on most cred purchases under the new tax law, although home equity financing programs could offs< much of this effect. In addition, consumers are highly leveraged. Finally, this year unlikely to bring another income windfall comparable to the sharp drop in petroleui prices that all of us, as consumers, enjoyed last year. These factors suggest a deceleration of consumer spending, though this large: component of GNP should continue to grow. It’s also important to bear in mind that the trade deficit narrows, even if consumer spending grows at a slower pace this yet than last, more of the goods consumers purchase should come from domestic producer Moreover, the anticipated stabilization in energy prices would help those areas of tt country affected most severely by the oil declines. Of course, some factors are likely to constrain growth in 1987. The chief areas < weakness are capital spending by businesses and construction. In addition, federal budg< deficits are on a downward slope. While Fm sure we all recognize the necessity of this,: means that government spending will not provide as much stimulus as it has in recer years. Business investment has been sluggish already because of low capacity utilizatio and overbuilding of offices and retail space as well as other structures. Changes in tii tax code will exacerbate this situation by treating some aspects of investment les favorably. In time this revision should lead to a more efficient allocation of capital c the revised tax code encourages investment dollars to be distributed more according 1 the dynamics of supply and demand. In the near term, though, we may see som uncomfortable adjustments develop as excess rental space is absorbed. Offic construction, along with apartment and condominium building, is likely to be weak in th year ahead. Though mortgage rates—now at their lowest level since the late 1970s- should boost the single-family housing market, demand, to a considerable extent, he Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- been met for the time being, and the chief determinants of new home sales will probab be demographics and overall economic growth. Even taking several of my concerns into account, I am confident that increase exports and domestic sales together with decreased energy costs should be sufficient 1 sustain the present level of growth for another year. The same forces, steady oil price and shifts in international trade, will also dominate the inflation picture. Prices < petroleum and other commodities and long-term interest rates are still well below the levels of a year ago, but without the boon of declining energy and commodity price measures of inflation should return to their pre-1986 pattern. Moreover, prices < imported goods, excluding petroleum products, which until recently have been an ant inflationary force, rose about 10 percent last year compared to the general inflation rat of less than 2 percent. Initially, foreign manufacturers shaved profit to maintain mark< share, a strategy that has become increasingly untenable as the dollar continued i decline. Despite these caveats I don't foresee an upsurge in inflation. In spite of all tl attention it receives, international activity is still a small proportion of total GNP, ar for that reason I think that the rise in prices of imported products will not push tl inflation rate over the 3 1/2 percent range during 1987. In sum, I feel that the appropriate attitude when looking toward 1987 and beyond one of patient optimism. The stock and bond markets persist in their bullish way indicating investors' confidence in our economic prospects. As the dollar drops, foreig markets reopen, and domestic consumers return to American-made product manufacturers will be able to expand production and contribute to that balanced growt which I hope will spread to those areas of the nation that did not share the expansion c the past year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- Outlook for the Southeast One of those areas is here in the Southeast, namely Louisiana, which has been hai hit by the contraction of the energy sector. The region also includes the robu economies of Florida and Atlanta, however. This diverse region reflected the nation picture in 1986 and will again in 1987. In general the economy of our district should sho improvement in 1987, perhaps exceeding the rate of gain foreseen for the nation economy once again. Continuing inflows of people and corresponding gains : employment and personal income are major reasons for the Southeast’s more rap: growth. Single-family residential construction should be a leader in the expectc increases, while commercial and multifamily construction will probably remain slow unt overcapacity has been absorbed. Manufacturing activities could supply a larger share < domestic as well as foreign markets, though because of technical efficiencies achieve during recent adjustments employment in some industries like apparel is unlikely to ru in proportion to its output. Workers will continue to find jobs in the expanding servi< and trade areas, however, so that the region's total employment should increase by aboi half a million new jobs in 1987. The agricultural and energy-producing sectors will be the lingering areas < weakness, not only during 1987 but perhaps for several years to come. Hea\ indebtedness incurred during periods of prosperity will continue to go unservice' resulting in additional bankruptcies and foreclosures among borrowers and loan losses f< lenders. Fortunately, the effects of the drought should largely be behind us. What more, we have seen an inching up in the rig count. If oil prices remain in the $15-1 area, the weakened energy sector should stabilize or even improve a little. Overall, tl Southeast seems likely to retain and even increase its attractiveness to new residents ai businesses both from elsewhere in the nation and from abroad, thereby keeping tl overall pace of growth in the region ahead of the nation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- Problems and Issues At each point in my remarks, the generally optimistic tone of my outlook for th Southeast and the nation is tempered by awareness of problems that could develop eve out of present strengths. Two lingering and related problems are the federal budge deficit and the trade deficit. When taxes were cut in 1980 without parallel cuts i spending, our government had to borrow increasingly to make up the difference. With rapid expansion in government debt, interest rates rose, and foreign investors becam increasingly active in the bond market, simultaneously bidding the dollar to great height as they scrambled for greenbacks with which to purchase government securities. Th damage done by expensive dollars was felt in the outright loss of markets for several o our industries. Though both seem to be on a downward course, much faster progress i possible. International policy makers have done about as much as they safely can t engineer reductions in the dollar; further currency realignment and trade adjustmer must come from substantial reductions in the federal budget deficit. Were such step undertaken, we would see a significant rebound in GNP growth and, with that, som significant declines in unemployment. Another continuing concern is the debt of the less developed countries, whic fortunately last year was mitigated through the diligent efforts of the Internationa Monetary Fund and American banking leaders. The situation need no longer be called crisis, but it remains a grave danger to our own economic stability as well as that of on neighbors. Default on outstanding loans would be an economic nightmare sending shoe waves through world financial centers. The concept evolved in negotiations wit Mexico—additional loans which will allow continuity of service on pre-existing debt- offers the most reasonable near-term solution and holds the most promise for progres toward more stable conditions there and in other debt-burdened LDCs that might folloi Mexico's lead. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -8- One of the most serious potential dangers I foresee in the months ahead is renew protectionist sentiment, which appears to loom even more ominously followi November’s mid-term elections. Politicians fearful of making the difficult decisions tti would address the federal budget deficit, the real cause of our foreign trade imbalam exploit public sympathies for displaced farm and textile workers as if tariffs or quot would somehow ease their suffering. The irony is, of course, that those two industries particular have been protected for years, and protection was not only unable to sa them but may have accelerated their weakening. The only thing that protections accomplishes is more protectionism in the sort of one-upsmanship that helped push t world toward the Great Depression of the 1930s. Since the end of World War II, it has been our country’s strategy to encourage fre market economies as alternatives to the types of government-controlled economies th led to hostility in the past. We rebuilt former enemies into trading partners in the beli that participation in competitive markets would help prevent a return to nak aggression or tyrannical domination. That farsighted strategy has borne fruit in 40 yes of relative peace and a world-wide standard of living that is much higher than anyo would have predicted at the end of the war. Our role as the engine of global growth h meant some sacrifices on our part, and it will continue to carry the responsibility championing freer rather than more restricted markets. Negotiations with individu countries, like those recently concluded with Canada on timber exports, and throu GATT and other international organizations are the correct avenues for adjusting tra inequities, not the political stump. If Congress is truly serious about helping American industry confront foreij competition, it can attack the budget deficit, which is the root of the problem. Unle Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -9- concrete steps are taken soon, future generations of Americans will pay dearly for ou profligacy. We can't go on borrowing forever. To avoid placing such a burden on ou children, policy makers have two reasonable alternatives: they must cut spending o raise taxes. Both require more courage than we have seen Washington demonstrate ii recent years, but doing nothing—the policy of default—keeps increasing the long-tern burden created by the need to service foreign debt. It threatens the future standard o living. Conclusion While seizing control of the foregoing problems will require vigilance and concert© effort for some time to come, I believe that the process can begin right now and I an optimistic about the eventual outcome. Thus, I feel I can end on a positive note afte dealing with some rather dark topics. The year ahead should build upon the moderate! expansive record of 1986 while moving toward better balance. The respite offered by ou economy's current stability provides an opportunity to work on answers to the har< questions I have posed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Robert P. Forrestal (1987, January 19). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19870120_robert_p_forrestal

@misc{wtfs_regional_speeche_19870120_robert_p_forrestal,
  author = {Robert P. Forrestal},
  title = {Regional President Speech},
  year = {1987},
  month = {Jan},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19870120_robert_p_forrestal},
  note = {Retrieved via When the Fed Speaks corpus}
}