Regional President Speech

THE ECONOMIC OUTLOOK FOR 1987 AND BEYOND Remarks by Robert P. Forrestal, President Federal Reserve Bank of Atlanta to the Miami Society of Professional Journalists January 24,1987 Good morning! I am delighted to be here with you today to kick off your seminar on business reporting. Personally, I have to say one of the most rewarding changes I’ve seen in recent years is the continuing rise in the status of the business section in local newspapers. People may still turn first to the sports pages, but I think it’s fair to say that general managers have recognized that having high quality coverage of economic news and business developments is just as important to readers as detailed reports on what's happening on the playing fields and at city hall. This conference testifies to that fact and indicates that the rising standards we've already seen are likely to continue climbing. The areas with which I am most involved, the economy and the financial services industry, are subjects that some of you probably cover, and I may have met you on previous trips to the state. Fve visited Orlando and Tampa not too long ago and met with members of the media as well as local business leaders and bankers. You may also have had some contact with the folks at our Florida-based operations. The Federal Reserve Bank of Atlanta has two branches in Florida—in Jacksonville and here in Miami. Despite the fact that the path of the Fed often crosses those of journalists, I wouldn't be surprised if many of your were not a bit uncertain about some of the functions performed by the Fed. Thus, I was delighted by Jack Hillhouse's invitation to speak here this morning on the outlook for the year ahead. At the beginning of the new year individuals review both their achievements and shortcomings in the past twelve months and look ahead to the coming year. Organizations do the same. The Federal Reserve wears three hats, so to speak, and accordingly has three areas to review and plan for—payments, bank regulation, and monetary policy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 - - Last Tear'S Performance At the Atlanta Fed, we feel we have completed another successful year of providing services to the U.S. Treasury and financial institutions in our District, which encompasses Alabama, Florida, Georgia, and parts of Louisiana, Mississippi, and Tennessee. We have recovered our costs in the areas of check clearing, cash services, and electronic funds safekeeping and transfer, as we are required to do by Congressional mandate. I expect next year to be another good one in the payments mechanism. In the area of bank supervision and regulation, though the number of bank failures nationwide was up rather substantially again last year as it was in 1985, I think we’ve done a good job of minimizing the broader risks and providing a smooth transition for those institutions that have gone under in the Southeast. The addition of examiners and the tightening of procedures that was a major initiative last year gives me confidence that we have in place a much better mechanism for anticipating problems, at least those under our jurisdiction. Nationally and internationally, of course, more work remains to be done to help the financial system adapt to the economic and technological realities of today. Some of these changes involve additional deregulation to bring about greater fairness and more economic efficiency; others entail, if not reregulation, at least a new and better approach to regulation. Deposit insurance and off-balance sheet items are just two issues that come to mind when I think about an agenda for improving the regulatory framework. The third function of the Fed, monetary policy, is the one that involves us most directly with the economy, which is the main focus of my remarks today. In this area too I think we have done reasonably well. Economic growth was pretty good for the fourth year of an expansion, and inflation came down again. The unemployment rate changed very little, however. These results might have been worse if the Fed had not pursued a fairly accommodative monetary policy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 6 - - GNP, adjusted for prices, grew 2 1/2 percent last year. That was close to par for our nation's postwar performance, but with ample excess capacity in the nation the rise did 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 makers provided considerable stimulus to demand. Despite the vitality of consumer spending, other major components of GNP, particularly capital spending by businesses and net exports, were weak, dampening growth. Given this relatively moderate pace of expansion, it has been difficult to nudge unemployment down to the more acceptable 6 to 6 1/2 percent range from the 7 percent mark, where it remained lodged for most of the year. Fortunately, it did decline to 6.7 percent in the final month of 1986 though Fm reluctant to interpret one month as a trend. Despite this modest pace of economic activity, I think things could have been worse under a different policy approach. Lowering the discount rate on three occasions, along with open market operations which generally assured an ample supply of credit, certainly helped make possible the growth we had in construction and consumer durables. The measure by which we have done best is inflation. The consumer price index will rose 1.9 percent—a lower rate than almost anyone expected and the lowest since 1965. Wholesale prices actually declined. Unfortunately I don't think the Fed can take as much direct credit for this as we did for the progress against inflation achieved earlier in the 1980s. The low level of price increases was a pleasant surprise attributable primarily to the drop in oil prices. After falling briefly below $10 per barrel, oil prices settled in at around $14 to $15 per barrel, bringing respite from the inflationary tendencies fueled by higher energy costs in the recent past. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- Forecast for 1987 Turning to the economic outlook for 1987, I foresee the expansion continuing a about the same pace as last year, that is around 2 1/2 percent. That rate of growth j 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 t 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 o energy prices, and, most importantly, the international sector. Though still a small par of our economy, the international sector is really the peg on which expectations c economic growth are hung. The dollar’s high value on foreign exchange markets durin 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 on trade position has exerted a tremendous drag on overall GNP growth—shaving as much a a point or more off total GNP growth. It has also had a devastating effect on local area whose economies are export-oriented or vulnerable to foreign competition. Fortunately, during the last two years the dollar has declined substantially agains the currencies of most of our major trading partners, though not against those of Canad and the newly industrializing countries of the Pacific. This depreciation in the dollar1 foreign exchange value has been raising the price of most foreign goods—with th important exception of oil—relative to domestically produced items. It should, ove time, provide U.S. manufacturers with stronger demand, from at home as well a abroad. A number of factors, including the sharp drop of oil prices and a subsequen surge in the volume of oil imports, delayed the adjustment of trade patterns to thi currency realignment, but beginning last summer the trade deficit at last diminished fo three successive months. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I believe the reversal in November will prove temporary and the trade deficit wil] continue narrowing in 1987, thereby boosting demand for American farm and manufactured goods and adding significant stimulus to GNP. Exports should increase moderately as prices of U.S. goods to foreigners become cheaper. However, the weakness of certain other major advanced economies will probably temper this tendency. Imports seem likely at least to stabilize this year in view of rising prices for most and the less volatile price of oil in recent months. This would also give a boost tc hard-pressed U.S. producers. Consumer spending should be sustained by reasonably healthy wage and salary growth and personal tax cuts that will increase disposable income of many households. Still, I don’t think we can count on the consumer as much as we have in the last few years to be the economy's chief expansionary force. Some consumer-financed consumptior could be discouraged by the phase-out of deductions for interest charges on most credil purchases under the new tax law, although home equity financing programs could offsel much of this effect. In addition, consumers are highly leveraged. Finally, this year is unlikely to bring another income windfall comparable to the sharp drop in petroleum prices that all of us, as consumers, enjoyed last year. These factors suggest a deceleration of consumer spending, though this largesl component of GNP should continue to grow. It's also important to bear in mind that as the trade deficit narrows, even if consumer spending grows at a slower pace this year than last, more of the goods consumers purchase should come from domestic producers. Moreover, the anticipated stabilization in energy prices would help those areas of the country affected most severely by the oil declines. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- Of course, some factors are likely to constrain growth in 1987. The chief areas ol weakness are capital spending by businesses and construction. In addition, federal budget deficits are on a downward slope. While I'm sure we all recognize the necessity of this, it means that government spending will not provide as much stimulus as it has in receni years. Business investment has been sluggish already because of low capacity utilizatior and overbuilding of offices and retail space as well as other structures. Changes in th< 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 a: the revised tax code encourages investment dollars to be distributed more according t< 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, ha: been met for the time being, and the chief determinants of new home sales will probablj be demographics and overall economic growth. Even taking several of my concerns into account, I am confident that increaset exports and domestic sales together with decreased energy costs should be sufficient t< 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 o: petroleum and other commodities and long-term interest rates are still well below theii levels of a year ago, but without the boon of declining energy and commodity prices measures of inflation should return to their pre-1986 pattern. Moreover, prices o: imported goods, excluding petroleum products, which until recently have been an anti­ 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 markei share, a strategy that has become increasingly untenable as the dollar continued it: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- decline. Despite these caveats I don't foresee an upsurge in inflation. In spite of all the attention it receives, international activity is still a small proportion of total GNP, anc for that reason I think that the rise in prices of imported products will not push the 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 is one of patient optimism. The stock and bond markets persist in their bullish ways, indicating investors' confidence in our economic prospects. As the dollar drops, foreigr markets reopen, and domestic consumers return to American-made products, manufacturers will be able to expand production and contribute to that balanced growth which I hope will spread to those areas of the nation that did not share the expansion oi the past year. Outlook for Florida Happily, these troubles have not hit Florida as hard as they have the United States Economic growth here has been faster than in the nation as a whole for a number ol years, and even though the state's expansion rate this year will probably decelerate somewhat, growth here promises to outpace the United States once again in 1987 Continuing inflows of people and corresponding gains in employment and personal income are major reasons for projections of the state's more rapid growth. Migration of new people to Florida has contributed to a rate of population growth three times greater thar the nation's in the 1980s. This steady stream of new residents in turn propels two ol Florida's largest economic sectors—trade and services. Recent arrivals expand the demand for shopping centers, hospitals, movie theaters, restaurants, and a variety ol other services beyond current capacity, generating new jobs in the process. Short-term migrants, better known as tourists, also boost the state's service anc trade businesses. At the same time they expand local and state government coffers Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis through the sales tax they pay on purchases made here. Last year was a good one fo Florida tourism. The dollars depreciation, along with fear of terrorism, encourage) Americans to travel in the United States rather than in Europe and more foreigners t< visit the Sunshine State. Since more foreigners visit Florida than any other state, th< increase in foreign visitors was significant for the state. Domestic travel to Florida di< not rise as much as some had hoped. Discount airfares attracted many Americans t more remote U.S. destinations like Hawaii and to the Caribbean. On the whole, though this year was a good one for tourism. Relatively cheap gasoline prices and the currenc; realignment we’ve had should make 1987 another good year, attracting foreign visitors a well as domestic travelers to Florida. Population growth is also usually associated with a booming construction industr; because added families need more houses and apartments as well as offices and retai space. However, the state has seen considerable overbuilding in recent years. Singl< family residential construction will probably show no growth this year, and multifamil; housing, office, retail, and industrial building is likely to decline. Although Florida has progressed rapidly and far toward the service economy that w< read so much about, extraction of raw materials and making them into goods is stil important in the state’s economy. In fact, manufacturing's share, while still less than ii most other states, has been a growing source of stimulus as it has undergone a transitioi from dominance by natural resource processing, that is, food, paper, chemicals, an< lumber production, to high value added industries like electronics. This yea manufacturing should receive an impetus from the dollar’s decline and the resumption o serious work on the space shuttle. Much of the state’s industrial sector produce: electronic transportation equipment tied to the defense and the space programs, ant accordingly what happens to those public sector programs is quite important to privatt industry here. Unfortunately, the benefits of new shuttle efforts probably won't be fel Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis until after mid-year, and, with the plateauing or even slowing of defense spending growth of other technologically advanced industries will be dampened. However, thi declining dollar's effect on prices of electronic parts and products abroad should bolste Florida’s high tech manufacturing to some extent. Though the forest products industry is being eclipsed by high tech, it is still ai important employer and one whose outlook is difficult to forecast. Canadiai competition, which has been fierce in the softwood market for which most Florida tree are destined, should be muted somewhat by our northern neighbor's agreement to impos a 15 percent export levy on timber leaving that country. However, demand for sue! lumber could well soften as residential builders regroup and await the absorption of th surfeit of apartments and condominiums nationwide. (Softwood lumber is an importan component of these buildings.) Moreover, the new tax treatment of pulpwood and lumbe is less favorable for forest-products businesses. Thus the year for Florida manufacturin; should be mixed. Other traditional economic activities—farming and mining—also continue to play a: important role in Florida's economy. Florida has escaped many of the problems i agriculture that have made headlines in the midwest and the Southeast. Most parts o the state did not suffer the severe drought that devastated Georgia and other parts o the Southeast. In addition, Florida’s farm products—citrus and vegetables—are les affected by the international economic dynamics that have proven so adverse to grail producers. Citrus production in 1987 promises to be excellent, in fact the largest ii three years. Demand for Florida vegetables should be healthy this year even thougl competition from Mexico and the Caribbean will probably not abate dramatically Mining, on the other hand, faces continued bleak prospects. Florida has considerable phosphate deposits, but because of foreign competition and weak worldwide demand fo fertilizer I don’t foresee growth on the horizon of this industry. To keep things ii Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis perspective, though, we must remember that this is a small component of the state's economy. Summing up the outlook for Florida, despite probable weak spots in construction and certain industries, the state is likely to retain and even increase its attractiveness to new residents and businesses both from elsewhere in the nation and from abroad, thereby keeping its overall pace of growth ahead of the nation. Problems and Issues At each point in my remarks, the generally optimistic tone of my outlook for the Florida and the nation is tempered by awareness of problems that could develop even out of present strengths. Two lingering and related problems are the federal budget deficit and the trade deficit. When taxes were cut in 1980 without parallel cuts in spending, our government had to borrow increasingly to make up the difference. With a rapid expansion in government debt, interest rates rose, and foreign investors became increasingly active in the bond market, simultaneously bidding the dollar to great heights as they scrambled for greenbacks with which to purchase government securities. The damage done by expensive dollars was felt in the outright loss of markets for several of our industries. Though both seem to be on a downward course, much faster progress is possible. International policy makers have done about as much as they safely can to engineer reductions in the dollar; further currency realignment and trade adjustment must come from substantial reductions in the federal budget deficit. Were such steps undertaken, we would see a significant rebound in GNP growth and, with that, some significant declines in unemployment. Another continuing concern is the debt of the less developed countries, which fortunately last year was mitigated through the diligent efforts of the International Monetary Fund and American banking leaders. The situation need no longer be called a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis —X J-— crisis, but it remains a grave danger to our own economic stability as well as that of our neighbors. Default on outstanding loans would be an economic nightmare sending shock waves through world financial centers. The concept evolved in negotiations with 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 progress toward more stable conditions there and in other debt-burdened LDCs that might follow Mexico's lead. One of the most serious potential dangers I foresee in the months ahead is renewec protectionist sentiment, which appears to loom even more ominously following November's mid-term elections. Politicians fearful of making the difficult decisions thal would address the federal budget deficit, the real cause of our foreign trade imbalance exploit public sympathies for displaced farm and textile workers as if tariffs or quota: would somehow ease their suffering. The irony is, of course, that those two industries ir particular have been protected for years, and protection was not only unable to sav« them but may have accelerated their weakening. The only thing that protectionisnr accomplishes is more protectionism in the sort of one-upsmanship that helped push the world toward the Great Depression of the 1930s. Since the end of World War II, it has been our country's strategy to encourage free- market economies as alternatives to the types of government-controlled economies thal led to hostility in the past. We rebuilt former enemies into trading partners in the beliei that participation in competitive markets would help prevent a return to nakec aggression or tyrannical domination. That farsighted strategy has borne fruit in 40 years of relative peace and a world-wide standard of living that is much higher than anyone would have predicted at the end of the war. Our role as the engine of global growth has meant some sacrifices on our part, and it will continue to carry the responsibility oi championing freer rather than more restricted markets. Negotiations with individual Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -12- countries, like those recently concluded with Canada on timber exports, and through GATT and other international organizations are the correct avenues for adjusting trad( inequities, not the political stump. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Robert P. Forrestal (1987, January 23). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19870124_robert_p_forrestal

@misc{wtfs_regional_speeche_19870124_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_19870124_robert_p_forrestal},
  note = {Retrieved via When the Fed Speaks corpus}
}