Regional President Speech

Robert T. Parry, President Federal Reserve Bank of San Francisco Economic Club of Phoenix, Scottsdale, AZ for delivery November 26, 1990 12:00 Noon PST A Perspective on the Economic Slowdown I. News on the economic front hasn't been too good lately: A. Problems in the Middle East have caused oil prices to fluctuate wildly. B. Even though the economy appears to be contracting, inflation remains a thorny problem. C. And, the stock market and the dollar are well below their pre August levels. D. Today, I plan to give you a perspective on recent developments, including comments on the consequences of the hike in oil prices, and the broad implications for monetary policy. II. Turning first to the national economy, it's useful to begin by looking back a few years to get a better perspective. A. We've enjoyed a remarkable peacetime expansion. From 1982 to '89, economic growth has been vigorous -- averaging 3!% a year. B. Such rapid growth pushed the economy to the limits of its capacity -- and maybe beyond, contributing to the increases in inflation we've seen since 1986. C. To reduce the strain on our economy's resources and to get inflation under control, the pace of activity needed to slow down. D. And, starting in early 1989, that's exactly what happened. Since then, the economy has grown at a 1l% annual rate, on average, in contrast to the 3l% growth rate in 1988 (Q4-Q4) and the 5% rate in '87. III. Given these numbers, developments in the Middle East, as well as the so called credit crunch, take on a more ominous cast. I'll say a few words about each. A. First, the credit crunch. To me, "credit crunch" refers to a situation in which money is not available to broad groups of borrowers at any reasonable price. It's not clear that this is the case today. 1. It's true that lenders -- and borrowers -- have become more cautious. 1 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2. But caution is a normal and healthy response to an environment that has become riskier. a. More prudent lending ·standards should be applauded because they enhance the stability of our economy. 3. Research at the San Francisco Fed does suggest that bank lending nationwide has been somewhat lower than would normally be observed at this stage of the business cycle, although this development has not been evident in the Twelfth District. 4. However, given that many borrowers have sources of credit other than banks, it remains to be seen how much of an effect reduced bank lending will have on overall economic activity. B. A more thorny problem is the situation in the Middle East and its impact on oil prices. 1. The price of West Texas crude has jumped from under $17 a barrel in June to over $40 at times. Now, it's 2. There's no telling how long Iraqi and Kuwaiti oil supplies will be off the world market. 3. But Saudi Arabia's and other countries' increased production is making up for the shortfall. a. Assuming no war that knocks out capacity in the Gulf area, the oil price probably will settle at around $25 per barrel. 4. If there is a war, however, we could be in for a long bout of even higher oil prices, which would further stunt economic growth in the U.S. and around the world. a. Inflation also would be higher for a time. 5. A rise in the price of an important raw material like oil reduces the capability of our economy to produce. 6. No amount of monetary stimulus can alter the fact that the economy must adjust to higher priced oil and its effects on production costs. 7. I hope we learned this lesson from the oil price shocks of the 1970s. a. In each case, policy was too stimulative at first. This postponed the inevitable decline in output associated with the oil price shocks. 2 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis b. But it also revved up inflation. c. Policy then had to shift gears and try to bring inflation under control. This tightening, coupled with the economy's need to adjust to higher oil prices, helped to bring on recessions. 8. In the current situation, then, the main contribution the Fed can make is to follow a steady course, taking care not to worsen the problems caused by the oil shock. IV. Let me turn now to the economic outlook for the months ahead. A. For 1990 as a whole, growth probably will come in at a very sluggish pace of around one-half percent. B. In the current quarter, output appears to be declining. 1. Weakness is showing up in nearly every sector of the economy -- the one exception may be our foreign trade balance, which should benefit from the lower dollar. 2. Higher-priced oil since early August is going to be a big negative for a while. · a. If the price remains high it will make our current plant and equipment less productive, for one thing. b. And it has cut into households' budgets and forced cutbacks on consumer expenditures. C. In this regard, I might note that the economy of the Twelfth Federal Reserve District -- including nine western states -- is less oil-dependent than other parts of the country, and Arizona's per capita oil consumption is particularly low. So the effects of the Middle East crisis may not be quite as painful here as they might be elsewhere. 1. In fact, the West generally has fared relatively well so far in the face of the slowdown in the rest of the nation's economy. a. This is due largely to the strong population growth we've seen. b. Nevertheless, the western economy as a whole is affected by the same forces that determine the pace of economic activity nationally. Indeed, as the national economy has slowed, most western states have seen growth slow down from the robust rates seen a year or so ago. 2. Arizona is one of only a handful of states where conditions 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis actually look brighter than they did a year or two ago. a. To be sure, poor conditions in real estate and construction continue to be a drag on the state's economy. b. But population growth more than double the national average, and robust growth in the trade and service sectors, have boosted employment growth to more than twice the national rate. 3. Despite the current areas of weakness, I think the Arizona and western economies are fundamentally sound. They should continue to outperform the nation, though that may be cold comfort if the national economy heads into a period of prolonged decline. D. Fortunately, for next year and beyond, there's reason to expect a modest upswing in the pace of overall activity. 1. The sharp drop in the dollar since last Fall shou}d provide a boost to the economy next year. a. A lower dollar makes our exports more attractive, and thus should help to improve our trade balance. b. Moreover, growth in ·most of our major trading partners has been more rapid than here, giving an added boost to our exports -- (1) even though the possibility of slowdowns abroad, particularly in oil-dependent countries, makes the extent of improvement uncertain. (2) Efforts in Japan and Germany to suppress inflationary pressures also threaten to slow economic growth of our major trading partners. 2. Ironically, another positive factor could be the price of oil. As I have mentioned, assuming war is avoided in the Middle East, the price of oil may stabilize at lower levels. This would boost our economy. E. The final factor in the outlook I want to mention is the recent federal budget agreement. 1. That agreement is estimated to cut nearly $500 billion from the federal deficit in 1991-1995. a. of this reduction is accomplished through Nearly~ less spending (and up to t of these cuts are in defense). The remainder of deficit reduction comes 4 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis from higher revenues (mainly excise taxes, medicare fees, and individual income taxes). 2. I support efforts to eliminate the federal deficit because of its detrimental effects on capital formation and economic growth. If the new package actually is implemented, it should contribute to prosperity in the U.S. economy in the long run. 3. In the short-term, however, the recent package is estimated to reduce the deficit by $40 billion in fiscal year 1991. Thus although deficit reduction is a plus for the economy over the long haul, it will be a negative factor for real GNP growth next year. F. But on balance, the best odds are that the positive forces for growth that I have mentioned will be strong enough to produce a modest pickup in the economy in 1991, following the weakness at the end of this year. 1. However, movements in the price of oil and the as dol~ar, well as the pace of economic growth abroad, will have an important bearing on how things unfold. V. On the inflation front, the news has not been encouraging. A. Consumer prices rose at more that a 61% annual rate during the first nine months of this year. Even excluding food and energy, consumer inflation exceeded St%. B. The lower dollar does not bode well for inflation over the next year or two. C. The trend in wages, salaries, and benefits also has not been encouraging. These costs rose by 5% over the 12 months ending in September. 1. Although this figure is down slightly from the previous quarter, it still represents unacceptably strong underlying pressure on inflation. VI. Nonetheless, many are suggesting that the current pace of activity calls for a significant easing of monetary policy, especially since the rise in oil prices could slow things further. A. I want to emphasize that the risk of a downturn is one of the Fed's most important concerns in its monetary-policy deliberations. B. At the same time, however, we've got to be careful not to over react to today's weak economic numbers. 5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis C. Indeed, with the oil shock and the lower dollar adding fuel to inflation, a significant move towards ease by the Fed might well cause long-term interest rates to rise, especially from today's levels. VII. Thus we're faced with a rather daunting task. We must guard against recession, but not lose the fight against inflation. A. Unfortunately there are no guarantees in this process. B. However, monetary policy needs to keep its primary focus on the longer term. Only by bringing inflation under control will we be able to promote maximum economic growth in the U.S. economy in the years ahead. 6 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Robert T. Parry (1990, November 25). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19901126_robert_t_parry

@misc{wtfs_regional_speeche_19901126_robert_t_parry,
  author = {Robert T. Parry},
  title = {Regional President Speech},
  year = {1990},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19901126_robert_t_parry},
  note = {Retrieved via When the Fed Speaks corpus}
}