Regional President Speech

Silas Keehn: Monetary Policy Remarks November 1987 Economic Forums 11/10/87 -- Madison, WI (breakfast) 11/10/87 -- Janesville/Beloit, WI (lunch) 11/5/87 Slide #1 -- Title Slide: Challenges for Monetary Policy I. If we had met with you a month ago A. Focus of some of my remarks would have been different '~ ~ °' ~~ ~~ B. But, events of past month illustrate the challenges ' µtc, , v~ ~ faced by monetary policy both in the short-run as well C. The outlook that Karl has just given represents what I Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ✓~ • would consider to be ~ good economic growth and inflation outcomes, especially since the current expansion is 5 years old this month 1. V~ ~ chievement of our economic growth outlook a. Is highly dependent on a turnaround in our international trade b. Moreover, there is greater uncertainty surrounding this forecast because of recent · stock market developments 2. On the inflation side, 11/5/87 Policy Remarks Page 2 a. We know that the adjustment process by which a turnaround in trade comes about necessarily means higher import prices and upward pressure on our domestic inflation rate b. But, again, recent developments seem to have burst the inflation psychology balloon--at least / ~ ~ ~ ~ pJ, c... r ~ • 7:,._ /\....<$le. D. This tradeoff between economic growth and inflation, of for now course, represents the perennial and pivotal policy issue faced by economic policymakers such as myself E. But our decisionmaking process has become more complicated because the economy we live in today 1. Is very different from that of just a few years ago 2. Indeed, in some respects, the current environment is quite different from that of just a few weeks ago F. What I want to do today is first comment on recent developments and then turn to some of the longer-term issues facing monetary policymakers Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy ~emarks Page 3 Slide #2 -- Chart: S&P 500 Stock Price Index (monthly) 11. The most significant recent development is one you are all well aware of A. Stock prices here, as well as in other countries, have fall en sharply B. I'd be a genius if I could tell you with certainty what vJf -~ - ' ''/Cr.-L,, ) ,, the exact cause of the drop was ~ / O<.,,(r ~ ( M / . ~ ~ '7"-'t:.J ~ . - ~ " l ~ : t . q 1. Seems to be more than the expected correction to the Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis run-up in stock prices earlier this year 2. Jury still out on how much deriviative markets, program trading, and the like caused or contributed 3. At least in part seems somehow related to our inability to come to grips with imbalances in our international position and our federal budget deficits a. Two issues that I'll talk about later ~. ~ ~~~ ~&,t_f u._.() -kn_°'- ~,~,. 0 - - ~ C 1 ~ 71£ 0.. o,A.R ~ - - , !,-, (./ tr.. ~.q/ - ~ ~ 11/5/87 Policy Remarks Page 4 Slide #3 -- Text Slide: Long-run/Short-run Monetary Policy Concerns Ill. But, whatever the reason, the fall and volatility in stock prices has meant a significant shift in the current thrust of monetary policy A. This shift highlights the longer-run as well as shorter-run concerns of monetary policy B. Over the long-run, monetary policy is concerned with achieving an appropriate balance between economic growth and inflation C. In the shorter-run, when events such as the stock market Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis drop occur, monetary policy appropriately must be concerned with maintaining the integrity of the financial system 1. Fed's role as "lender of last resort" 2. If 1929 taught us anything, we know the importance of pursuing policies that prevent instability in the stock market from spreading to the rest of the financial system -- particularly the banking system 11/5/87 Policy Remarks Page 5 Slide #4 -- Text: Fed's 10/20/87 Statement IV. The Federal Reserve's response to the stock market drop was quick and, I believe, has been successful in containing the problems so far A. Following the historic 508 point drop in the Dow Jones tpfbt'~', , ~ industrial average on October 19, and before U.S. stock ~ markets opened on October 20 '~~~ B. Chairman Greenspan released the following statement: C. "The Federal Reserve, consistent with its Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." ¼· ~ - 6-)"- AM'fl; ~\:1r;; ~'\/~ v~ r~~,l✓~ ~ ~~ 11/5/87 Policy ~emarks Page 6 Slide #5 -- Text: Federal Reserve Response V. In support of this position -- in the days since Oct 19 A. We have provided a more than ample supply of reserves to the banking system through our open market operations 1. We have been in the market virtually every day--often earlier than the usual "Fed Time" --buying sizable amounts of securities--a process that adds liquidity to the banking system 2. We've lent securities needed by dealers to complete transactions thus assuring smooth functioning of the markets B. If needed, our discount window facilities are ready to accommodate the needs of the financial system C. We've extended our wire transfer hours to facilitate the huge transfers of funds associated with stock market activity D. We've been in constant contact with market participants Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis in order to assess developments as they occur 11/5/87 Policy Remarks Page 7 E. Our monitoring activities have not been solely on financial markets -- also goods markets 1. We've also stayed in touch with those in the business community to determine the extent of financial market developments on spending plans and current situation As a result, we've not experienced a run on banks 1. Indeed, just the opposite has occurred 2. Our evidence suggests there's been a flow of funds into the banking system G. I can assure you that we will continue to provide sufficient liquidity until confidence has been restored r ---..., ------ H. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis and financial markets have been stabilized But, once this storm has passed, 1. Then monetary policy will need to once again refocus on its longer-term goals 2. And, the challenges facing monetary policy prior to the stock market fall will once again be before us. 11/5/87 Policy ~emarks Page 8 0--:~ ~r~~E:::m ~ VI. ~ vents surrounding the stock market collapse illustrate clearly what I consider to be perhaps the most significant change we've seen over the past few years A. The "Globilization" or "Internationalization" of the U.S. economy and our financial markets B. Over the past few years we have become increasingly cognizant of the interdependencies between the U.S. economy and the economies of the rest of the world This has become apparent in the growing importance of trade flows for the health of our own economy as well as the health of other economies 2. It has become apparent as well in our growing reliance on funds from abroad and resulting closer connections among financial markets worldwide 3. And with this interdependence of trade and financial flows, the need for policy coordination between the U.S. and other countries has never been greater Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 9 B. U.S. policymakers cannot consider only domestic issues 1. Must be aware of the implications of our actions for the rest of the world 2. Must be aware of the implications for us of actions taken abroad Slide V 11. # 7 -- Text Slide: Leveraging of America A second major change might be called the "Leveraging of America." Over the past few years there has been an enormous buildup of debt across all sectors of our economy. A. Debt of the Federal government as well as state and local governments has grown at an extremely rapid pace. B. Debt-to-income ratios for U.S. households are near record high levels. C. Corporate debt-to-net worth ratios are also historically high. D. And, as a nation, we are now the largest debtor country Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis in the world. 11/5/87 Policy Remarks Page 10 Slide #8 -- Text Slide: Major Economic Imbalances VI 11. Related to these two major changes in the economy -- the globilization and the leveraging of America A. Are two major imbalances in our economy -- often referred to as the "twin deficits" 1. Large international trade deficits which are symptomatic of the globilization process 2. Large federal government budget deficits and resulting rapid federal government debt growth -- a prime example of the leveraging of America B. Obvious that there are many issues related to these twin Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis deficits 1. Can't discuss them all in detail 2. But to understand position of monetary policy a. Important to be aware of broad dimensions of these imbalances 11/5/87 Policy Remarks Page 11 Slide #9 -- Transition Slide: International Trade Imbalance IX. To begin, let us consider our international trade imbalance Slide #10 -- Chart: U. S. Current Account X. All of you are well aware of the fact that we've had enormous international trade deficits over past few years A. This chart -- showing our current account balance, which is our broadest measure of U.S. trade performance demonstrates the magnitude of that imbalance B. Until the past few years, we traditionally had current account surpluses 1. That is, our merchandise and service exports plus our investment income receipts exceeded our imports of goods and services plus our investment payments to foreigners C. Over past 25 years Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. Relatively small current account deficits occurred first in 1971 {$1.4 billion) and 1972 ($5.8 billion) Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 12 2. Somewhat larger deficits in 1977-78 (both $15 billion) 3. Very sizable current account deficits since 1982 a. Deficit last year at record $141.4 billion b. First half of 1987, at annual rate of $155.8 billion 4. Fallen like a stone 5. July and August numbers on our merchandise trade deficit (part of current account figures) -- still very disappointing 11/5/87 Policy Remarks Page 13 Slide #11 -- Chart: Current Account vs. Foreign Capital Inflow XI. There's a counterpart to our trade deficit we must recognize A. Namely, that what happens to our current account balance Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis is equal to what happens to our foreign capital flows 1. If we run a current account surplus, then we are net exporters of capital 2. On the other hand, when we run current account deficits, we become net importers of capital 11/5/87 Policy Remarks Page 14 Slide #12 -- Chart: Net International Investment Position of U.S. XII. And, the magnitude of our recent current account deficits and corresponding foreign capital inflows means that in five short years we have gone from being the largest creditor nation to being the largest debtor nation in the world A. Now this position in not inherently wrong, if funds are used for productive purposes which generate the repayment capacity to service the debt B. It is wrong to use the funds for consumption purposes -- Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis and unfortunately that basically is what has happened 11/5/87 Policy Remarks Page 15 Slide #13 -- Chart: U.S. Imports and Exports: Nominal XIII. When we look at what's happened to the nominal or current dollar value of our imports and exports of goods and services since the dollar began falling in early 1985 A. We see that despite the fall in the value of the dollar, progress toward solving our international trade imbalance has been painfully slow B. The dollars spent by foreigners on goods and services we export have increased since the second quarter of 1986 1. After changing little on balance from 85Q1 to 86Q2 2. Dollar value of goods and services exported has risen at a compounded annual rate of 13% C. But, the dollar amount we've spent on imported goods and Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis services has continued to climb at a rapid clip 1. After 8-1/ 4% annual rate rise from 85Q1 to 86Q2 2. Picked up to almost 14% annual rate from 86Q2 to 87Q3 11/5/87 Policy Remarks Page 16 Slide #14 -- Chart: U.S. Imports and Exports: Real XIV. If we adjust for price changes, and look at the volume or quantity of goods and services traded A. The picture is only somewhat more promising ,/4 B. On the export side the story is similar to what's ,B happened to the dollar value of goods and services purchased by foreigners 1. After changing little on balance from 85Q1 to 86Q2 2. The quantity of goods and services we exported rose at an annual rate of nearly 13% from 86Q2 to 87Q3 C. On the import side, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. After climbing at an annual rate of 13% from 85Q1 to 86Q3 2. We saw a slight drop in the quantity of goods and services imported from 86Q3 to 87Q1 a. Had raised hopes that the turnaround was here 3. But, since 87Q1, the quantity of imports has once again risen rapidly--at an annual rate of 13-3/ 4% - 11/5/87 Policy ~emarks Page 17 Slide #15 -- Chart: U.S. Net Exports: Nominal vs. Real XV. A. The net result -- still large deficits in our net exports of goods and services {the difference between exports and imports): 1. The nominal or current dollar value of our net exports has continued to deteriorate 2. The real value = quantity of our net exports a. Which had shown signs of improving over the 86Q3 to 87Q2 period b. Worsened somewhat in 87Q3 B. We remain confident that our trade situation will turn around, but that turnaround is taking much longer than expected C. In the meantime, given the fact that our trade deficit is intrinically tied to our foreign capital inflows 1. Our reliance on foreign funds will continue until we have a turnaround in the dollar value of our international trade deficit Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 18 Slide #16 -- Transition Slide: Federal Budget Imbalance XVI. But, we have a second major imbalance in our economy that complicates our ability to solve our international imbalance A. That imbalance is our federal budget deficit B. Must correct the federal budget imbalance between spending and revenues C. Efforts to reduce the federal budget deficit must Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis continue 11/5/87 Policy Remarks Page 19 Slide #17 -- Chart: Federal Deficit as a % of GNP XVI I. Federal budget deficits of current magnitudes at this stage of the economic expansion are unprecedented A. Not at all unusual at the the time of recession or other adverse events 1. Indeed, many programs are specifically designed to ease the pain of recessions B. But we are now completing the 5th year of the current Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis economic expansion and until just recently we were running deficits around 4-1/2 to 5% of GNP 1. Unfortunately, large part of recent drop is temporary, due to large tax payments from last year's tax law changes 2. Deficit as a percent of GNP more likely to rise than fall in coming years if efforts to reduce the deficit stall/fail 3. We've never done this before 11/5/87 Policy Remarks Page 20 Slide #18 -- Chart: Total Gross Public Debt XVII I. Federal deficits result in Treasury debt A. Rising at an alarming rate B. Debt level in early 1975, $500 billion C. Surpassed $2 trillion level on April 1, 1986 D. Was $2.38 trillion as of 11/3/87 -- rising inexorably E. And, if the deficit in fiscal 1988 is $183 billion as Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis projected by the CBO last August 1. Over $725 million in new money, on average, needs to be raised each business day 2. Some $3.5 billion per week 11/5/87 Policy Remarks Page 21 Slide #19 -- Chart: Interest on Debt XIX. Interest on the debt has to be paid A. Growingly worried about compound interest syndrome . 1. Is this an issue that has gotten beyond our control? 2. Interest on the debt is assuming a much larger position in the annual budget -- 10% in fiscal 1976, 19-1/2% in fiscal 1987 3. Even on this basis alone, the need for action on the deficit is very compelling B. But, implications of continued high federal budget Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis deficits go further 1. At stake -- whole issue of allocation of savings and investment dollars between government and private sector 2. Of particular concern is that interest rates are higher as a result of budget deficit a. Some debate on this issue 11/5/87 Policy ~emarks Page 22 Slide #20 -- Chart: Uses of Total Available Savings XX. But when we look at how available savings have been used A. Large proportion soaked up by Federal deficits 1. Past 3-1/2 years, total available savings averaged 10% of GNP -- historically high 2. Federal deficit as % of GNP: 5.2% in 1983 4.5% in 1984 4.9% in 1985 4.8% in 1986 3.5% in first half of 1987 Record high percent for this stage of expansion B. It is only logical then that there has been pressure on Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis interest rates from the deficit 1. And private domestic investment squeezed out by those higher interest rates 11/5/87 Policy Remarks Page 23 Slide #21 -- Chart: Sources of Total Available Savings XXI. Would have been worse if we didn't have foreign capital inflow A. Foreign capital inflow augmented our domestic savings 1. On an annual average basis, domestic savings (= personal savings + undistributed corporate profits + state and local government surpluses) since 1970 ranged from a low of 6.5% of GNP last year (1986) to 9.9% in 1973 a. Was only 5.2% in this year's first half 2. Domestic savings, which accounted for virtually all of total available savings in 1982, provided only two-thirds of total last year 3. Savings from abroad provided the remaining one-third B. But, the expected turnaround in our international trade Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis deficit necessarily means that the amount of foreign capital coming into our country will be reduced 11/5/87 Policy ~emarks Page 24 C. One plus from the recent stock market events is more Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis serious budget negotiations between Congress and the President 1. I view this as fortunate even though smaller budget deficits mean less fiscal stimulus for economic growth 2. It's fortunate because recent trends do not point to an increase in our own domestic savings relative to our investment needs 11/5/87 Policy Remarks Page 25 Slide #22 -- Chart: Domestic Savings vs. Investment (as a XXII. % of GNP) As we can see on this chart, the margin or difference between domestic savings and domestic investment has been narrowing over the past few years A. As in our earlier chart, domestic savings includes personal savings, undistributed corporate profits, and state and local government budget surpluses 1. As a percent of GNP, our domestic savings still exceeds our domestic investment 2. But, that margin has been narrowing a. Was less than one-tenth of one percentage point in the first half of this year 3. And, don't forget, we still have a federal budget deficit exceeding 3-1/2% of GNP to finance B. As we see in this chart, the primary cause of the Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis savings/investment imbalance is the fall in savings side 1. And, that largely reflects what's happened to our personal savings rate 11/5/87 Policy Remarks Page 26 Slide #23 -- Chart: Personal savings as % of disp. personal income XXIII. This chart shows what's been happening to our personal savings rate A. Personal savings as a percent of disposable personal income has been well below 1960-1981 average of 7-1/ 4% during most of the current expansion 1. The 4.3% savings rate reported for all of 1986 was the lowest since 1949 a. And, we've had about a 3-1/2% savings rate so far in 1987 B. What this means is that the consumer is not providing Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis sufficient savings needed for both domestic investment and to finance the budget deficit 11/5/87 Policy Remarks Page 27 Slide #24 -- Chart: Cons. Installment Debt as % of Disp.Pers.lncome XXIV. Rather, the consumer has been on a spending spree, and to a large extent supported that spending spree by taking on huge amounts of debt -- part of the leveraging of America problem A. Consumer installment debt has risen to record levels relative to disposable personal income B. Although there are some mitigating circumstances which moderate the sheer magnitude of numbers 1. Increased use of credit cards for managing cash -included in figures though fully repaid each month 2. Demographics -- higher percentage of population in age groups that are typically borrowers 3. Longer-maturity loans imply lower monthly payments 4. More-than-offsetting increases in assets ) ~ V / (a) Although stock market drop changed that somewhat C. Nonetheless, personal debt loads have become very heavy Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. Raises the question as to the sustainability of consumption and, therefore, the economic expansion 11/5/87 Policy Remarks Page 28 2. Will consumers be able to handle this debt if personal incomes begin to fall? D. And yet another disturbing aspect, while recent consumer Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis debt-to-income ratio has leveled off (fallen) somewhat 1. Partially due to tax law changes and resulting shift to using home equity loans not included in the consumer installment debt figures 2. Not sure the consumer fully aware of the risks should economic situation turn sour. 11/5/87 Policy ~emarks Page 29 Slide #25 -- Chart: Funds Raised by Nonfinancial Corporate Business XXV. The consumer has not been alone in the increasing debt load picture A. Corporate debt in the U.S. also has increased sharply over the past few years 1. In 1984, consolidated corporate debt issued by nonfinancial corporations amounted to $196 billion -- a record 2. At $167 billion in 1985 and $192 billion in 1986, we saw the second and third largest amounts ever recorded. 3. Drop in first half of 1987 to $91 billion annual rate still represents significant increase B. Much of that debt used to finance the extraordinary pace Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis of mergers, leveraged buyouts, share repurchases and other restructuring plans of the past 3-1/2 years 1. In process, huge amounts of corporate equity retired 2. Such retirements far exceeded new issues offered 11/5/87 Policy ~emarks Page 30 3. So that net equity issues -- the difference between new offerings and retirements -- were significantly negative in 1984, 1985, 1986, and first half of 1987 4. Corporate America has been decapitalizing itself Slide #26 -- Chart: Corporate Debt to Net Worth Ratio As a consequence, corporate debt relative to net worth has XXVI. increased sharply in past three years A. From 60-64% range observed over 1970-1983 period to about 84% in 1986 (measured on historical cost basis) B. Debt service implications if this trend continues worrisome 1. Increased claim on future earnings means less internally generated funds available for investment 2. Debt service becomes more difficult if economy falters, if interest rates rise C. Destabilizing element -- Vulnerability Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 31 Slide #27 -- Text Slide: Policy Implications XXVI I. These imbalances clearly have important implications for U.S. economic policies A. Implications for the broad policy set 1. Fiscal policy -- taxing and spending 2. Regulatory policy -- market and industry structure and behaviorial restraints 3. And, for monetary policy B. Indeed, monetary policy alone cannot directly address these major imbalances 1. Clearly, Congressional actions determine budget and trade policies 2. And we know that savings and investment decisions are significantly affected by government spending and taxing policies C. But, these imbalances must nevertheless be taken into Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis consideration in monetary policy 11/5/87 Policy ~emarks Page 32 1. They are an important part of the environment for making monetary policy 2. And influence what monetary policy can do in affecting the economy D. In the current environment Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. The twin deficits -- budget and trade -- are of particular importance 11/5/87 Policy Remarks Page 33 Slide #28 -- Chart: Federal Budget Deficit Outlook XXVI 11. The importance of the imbalance in our federal budget is quite obvious A. U.S. fiscal policymakers should be seeking a better balance between federal government spending and revenues 8. In other words, they should continue to move toward reducing the federal budget deficit C. Results for fiscal 1987 were quite good 1. Budget deficit was "only" $148 billion, down sharply from $221 billion in FY86 2. However, much of that improvement reflected higher tax revenues from capital gains taken in late 1986 -- a one-time change due to Tax Reform D. Without further fiscal policy changes, budget deficit is Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis expected to rise over the next two fiscal years 1. FY88: $161 billion (0MB) vs. $183 billion (CBO) 2. FY89: $166 billion (0MB) vs. $192 billion (CBO) 11/5/87 Policy Remarks Page 34 E. And, if we get larger rather than smaller deficits 1. Additional upward pressure on interest rates since that deficit must be financed 2. Less savings available for our private investment 3. Continued heavy reliance on savings from abroad F. In other words, if the federal budget deficit is not Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis reduced, we will continue to have a tough time dealing with other imbalances in our economy 11/5/87 Policy Remarks Page 35 Slide #29 -- Chart: Domestic Spending vs. Output XXIX. To a large extent, the significance of the international imbalances for the U.S. economy can be summarized in this chart A. Which shows our domestic spending {Gross Domestic Purchases) as a percent of our domestic output (GNP) B. Over the past several years we've been spending far more than we've been producing 1. The difference between our spending and output reflects our net export position 2. That is, the excess of goods and services we've imported over those we've exported C. If we were to look at comparable data for our trading Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis partners 1. We'd see just the opposite situation 2. Since, by definition, our trade deficit must be reflected in trade surpluses of our trading partners taken collectively Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 36 3. This means that, in the aggregate, they've been producing more than they've been spending in order to meet demands for goods and services from the U ~S. 11/5/87 Policy ~emarks Page 37 Slide #30 -- Chart: Trade weighted dollar XXX. With the decline in the foreign exchange value of the dollar A. The production and spending relationships are being changed 1. We will need to produce more and spend less 2. Foreigners will have to spend more and produce less B. The lower dollar 1. Brings about a rise in our net exports and a fall in net exports of our trading partners 2. This translates into higher real GNP growth for us • but lower real GNP growth for other nations C. But the lower dollar also affects inflation 1. As prices on goods we import rise, that means that our inflation is higher than otherwise 2. For other nations, as the price of goods we export ·to them falls, that means their inflation is lower than it would have been Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy ~emarks Page 38 D. A "Catch-22" or a policy dilemma for us 1. While we would all like to have more economic growth 2. Is higher inflation the price we want to pay E. The policy dilemma for other nations 1. Lower inflation may be desirable 2. But is lower economic growth a price they can afford F. And in turn for us Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. If other nations have lower growth, can we expand our exports to them 11/5/87 Policy Remarks Page 39 Slide #31 -- Text Slide: Domestic Policy Goals XXXI. In final analysis, the primary objective of monetary policy A. Is to achieve maximum growth with price stability -- to balance these goals 1. Don't want more growth at the cost of inflation a. It doesn't buy anything in the long run 2. But we certainly want as much growth as we can get without price escalation B. This view of what monetary policy seeks in the longer-run is not inconsistent with what we might do in the short-run 1. Because of the fall in the stock market 2. Because of what might be happening to the foreign exchange value of the dollar C. Such events have implications Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. For economic growth 2. For inflation 11/5/87 Policy Remarks Page 40 D. And if such events move us away from balance between economic growth and inflation 1. Then our monetary policy must be adjusted accordingly E. In a longer-run perspective, the real question is what Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis growth is attainable 1. Currently, the twin deficits -- the federal budget deficit and the trade deficit -- are the major constraints to greater growth a. They may both be declining, or we hope they will, but their legacy is still with us b. We are paying the costs of our excesses c. Consequently, we may not be able to achieve much more rapid growth now 11/5/87 Policy Remarks Page 41 Slide #32 -- Chart: Real GNP, Actual and Trend XXXI I. In spite of imbalances in our economy, we are running close to our long-term growth path A. On this chart we show actual real GNP and its trend over the past four decades and trend over past 20 years 1. Over 40-year period, growth in real GNP averaged 3% a. But 3-1/2% trend growth from 1947-1966 b. And 2-1/2% trend growth since 1967 2. So, while somewhat below 40-year trend path a. We're very close to 67-87 trend path B. So, while recent stock market developments appropriately call for a more accommodative monetary policy at this time 1. We can't expect to continue such a stance forever C. At some point, attempts to achieve more rapid growth Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. Will run some risks to long-term price stability 2. Especially since we're already under price pressures from imports Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 42 a. If these pass through to other products and to wage rates generally b. Could get a systematic increase in inflation c. To longer-term detriment of economic growth 11/5/87 Policy Remarks Page 43 Slide #33 _:_ Chart: Consumer Prices XXX 111. The key challenge for monetary policymakers over the near future will be determining A. When sufficient liquidity has been supplied to assure economic growth continues 1. Without sacrificing the progress we've made on the inflation side B. From my perspective, it's essential that U.S. monetary Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis policymakers remain aware that the balance between our economic growth and our inflation is very important 1. The history of our inflation shown here by the yearto-year rate of change in consumer prices indicates that a. We've had good price performance in the last few years b. But, it wasn't so long ago that inflation was in the double-digits 11/5/87 Policy Remarks Page 44 c. The primary reason was unsustainably high economic growth d. To correct that imbalance in the past meant . recession e. That need not be the case now C. Once the current market situation has been stabilized, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis we can continue to see good economic growth with price stability 1. Provided that we remain aware of the implications for our economic growth and inflation of actions taken by other policymakers a. And work together to correct imbalances 2. Provided that we recognize that the recent rise in our inflation from higher import prices can be only a temporary increase -- a necessary part of the adjustment process in correcting our international imbalance Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11/5/87 Policy Remarks Page 45 3. Provided that we remain alert to, and respond appropriately to, the potential for these temporary price pressures being built permanently into our price structure a. From domestic producers raising prices unduly b. From wage increases that exceed productivity gains 11/5/87 Policy ~emarks Page 46 Slide #34 -- FRB Chicago Logo XXXIV. Concluding Remarks A. Tried to show economic environment very different 1. From few weeks ago a. Stock market fall b. Monetary policy response 2. From few years ago a. Globilization / buildup of debt b. Imbalances B. Monetary policy record good Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1. Market stability apparently restored 2. Excellent economic results likely to continue 3. Inflation - higher - but not unreasonable 4. Challenge - maintain growth rate - but don't let inflation rise to an unacceptable level 5. Every expectation we'll continue this record . • • • • • 

Silas Keehn (1987, November 9). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19871110_silas_keehn

@misc{wtfs_regional_speeche_19871110_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1987},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19871110_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}