Regional President Speech

! f I I I I I I I I A Reserve Bank President Looks at the FOMC Cathy E. Minehan, President Federal Reserve Bank of Boston University of Rochester Alumni Breakfast Bear Sterns & Co., New York June 19, 1996 1 I want to thank Gwen Greene for inviting me to speak with you here today. It's wonderful to see a whole room of U of R graduates, with whom I also share a background and career in economics and finance. This past couple of years have been an extraordinary period for me; one characterized by intellectual challenge and a defining sense of public service that, while not unexpected, has had a powerful impact on me. In large part this is because of my membership on the FOMC. I'd like to provide some insights for you about FOMC membership that might be an interesting way to begin what I know will be an engaging dialogue after my remarks. When people ask me about the Fed, and more specifically the FOMC, they usually are interested in two things: what really goes on in a process sense, and what is the substance of the Committee discussion, that is, what are the key issues focused on at any meeting? I'd like to talk about both of these areas today, and add a third--what is the role of a regional Reserve Bank President, and what effect do regional matters have on the formation of national monetary policy? Then I will conclude with a few remarks on the current economic scene. 2 It may come as some surprise to you, but the inner workings of the FOMC were as much a mystery to me when I began attending in March, 1994 as they may be to you--despite the fact that I had been with the Federal Reserve System for almost 27 years by that time. My predecessor Dick Syron was never away at the time of a meeting, and I never was a "back bencher" (that is, a senior economist or a director of research) so it was all new territory. And this territory didn't come with much of a map--Where do I sit? What really happens? And most importantly, how can I most effectively make the case for what I believe to be the right policy action? I've sought answers to all these questions over the past couple of years, so let me cover them for you, looking at process first and substance second. FOMC meetings come along every six-eight weeks or so and seem at times to be scheduled for maximum personal inconvenience. Why must we always meet on the day before or after July 4, and the Tuesday before Christmas? The real answer to this question is a mystery, but tradition I suppose plays a role. While in many ways one is always preparing for an FOMC meeting, formal preparation for each Tuesday meeting begins the prior Thursday or Friday when extensive information is distributed by the excellent staff of economists at the 3 Board of Governors. This material is of three general types: an exhaustive compendium of current economic statistics and analysis, focused on what has already happened; a baseline forecast with alternative scenarios, and a discussion of monetary trends and policy options. As you can imagine, all this material is shared among only a few economists, our Director of Research and myself at the Bank. We, of course, have our own perspectives on current economic data, and our own forecasts, and we carefully review the Board material to determine both where we might differ, and where we might agree. We at the Boston Fed are keen believers in controlling inflation, but we are also sensitive to the short-run effects of monetary policy. We look at the monetary aggregates for whatever information might be there, and we follow interest rate trends and data on financial market activity. But most of all we look at the product and factor markets of the economy as key predictors both of economic growth, and inflation. Our discussions of Board staff material tend to focus not so much on analytical differences, because we share a similar eclectic approach, but on where the risks are and what policy action should be taken. These discussions usually start on Friday and continue through Monday when I head off for Washington. 4 Once there, all FOMC participants receive another flood of paper in their hotel rooms. The Board members are briefed on Monday morning, and we receive this material as well as any last minute updates the staff has prepared. By the time the meeting comes around on Tuesday, I usually have such a full briefcase that I've often thought that weight training should be required for all Reserve Bank Presidents as an adjunct to FOMC preparation. FOMC meetings themselves, at least in my experience, have a rather set process, in contrast to the very free exchange of views that takes place. One does sit in an assigned seat both as a member at the table, and on the couches and chairs behind the table for the back benchers. The meeting opens with a discussion by the Manager of the System Open Market Account--currently Peter Fisher of the New York Fed--of both domestic and international market conditions, and actions taken by the Desk since the last meeting. Then senior members of the Board staff present their baseline forecast and alternatives. Each Reserve Bank President speaks about conditions in his or her region and about their reactions to the staff forecast material. Board members also reflect on various aspects of the national economy and their perspectives on the forecast. After this is done, without 5 exception we break for coffee, served with doughnuts and muffins in the hallway outside the Board Room. After the break, policy actions are presented to the Committee and the Chairman adds his perspective. He usually covers current economic activity and may present a recommendation. Then, each President and Governor expresses his or her own policy perspective, and what action he or she would prefer. Divergent points of view are not unusual, and there is lots of room for different economic philosophies. This, I think, is an important fact to keep in mind. While the formal process of the meeting follows a set pattern, the substance does not. There is no attempt prior to meetings to pull the Presidents together on a policy recommendation, and there would be strenuous resistance if that were attempted. Even in the coffee break prior to the policy discussion, there is little, if any, consensus building. Rather, the meeting itself is the place for honest, open discussion about both our economic philosophies and how they should be reflected in policy. These past two years have been an extraordinarily interesting time to be on the Committee from a substance perspective. In general, setting monetary policy is easier when all the signs point in the same 6 direction. For example, the combination of tight markets, low unemployment, and prospects for unsustainable rates of economic growth, all suggest a tighter policy is necessary. Conversely, high unemployment, prospects for slow or negative growth, and little price pressure suggest a more accommodative policy. But things aren't so easy when, as has happened over much of the last year to year and a half, there are at times no obvious directions for policy, only upside or downside risks to be understood and avoided. By any rational measure of economic policy, we seem to have achieved that economic equivalent of nirvana, the soft landing- relatively low unemployment, continued underlying sources of economic growth in consumer and business spending; interest rates at levels that at least for the present don't seem to have significantly affected housing markets and business finance; very few price or wage pressures; ebullient though at times volatile stock and bond markets; and a declining fiscal deficit. The issue now is how to keep things on track without on one hand being so tight that growth is stifled, or so loose that inflation takes control. And if you look over past history, our track record in smoothing out and extending the growth phases of economic cycles, while improving during the eighties and early 7 nineties, is anything but perfect. Clearly this isn't easy to do, but to be at all successful we on the Committee need to listen to each other's perspectives. Where are the risks in this economy? Are they on the upside as it seemed in February 1995, with growth strong and labor markets tightening? If so, should we take advantage of the seeming health of the economy and purchase insurance, as we did then against rising rates of inflation? Are the risks on the downside, as it seemed later in the year, when we moved to ease policy in the face of low rates of wage and price growth? Have things really changed out there in the labor markets with globalization, technology, and ever increasing competition so that wage pressures are permanently lower at any given level of unemployment? It is tempting to believe this is true, but do we have enough confidence in the data so far to avoid the surge in inflation we experienced in late '89 when similar arguments were made? Has all the investment in computers and productive capacity changed our underlying ability to grow to the extent that more workers can be absorbed than we could expect from historical relationships? And what, if anything, needs to be done about the possibility of fiscal drag when the framework for a i 8 balanced Federal budget is approved, with all that such an agreement could imply for even lower federal budget deficits and lower long-term interest rates? These are issues that have absorbed each of us on the Committee over the last year whether implicitly or explicitly. And whether we come at them from the prospect of a "hawk" or a "dove," as they are rather simplistically characterized by the media, we all have a similar appreciation for the necessity over the long run to keep rates of inflation low. To reiterate some economic basics, over time, the long-run growth rate of the economy can for all practical purposes only be increased through higher rates of productivity. In turn, higher rates of productivity growth can only be achieved through higher rates of domestic savings and investment. And, finally, higher rates of saving and investment will occur most readily in an environment in which the threat or reality of inflation does not distort the decisions of savers or investors. I think we have only to look at the progress this country has made since 1982, when the back of the high rates of 1970s inflation was essentially broken, to recognize the benefits that can be realized from a restrained inflationary environment in terms of increased 9 international competitiveness and renewed emphasis on productive investment. Thus, I start from the maxim that whether at any moment in time the primary concern is inflation or economic growth, the best policy over the longer run is to remain vigilant against inflation. This is a variant of the old maxim--an ounce of prevention is worth far more than a pound of cure. Moreover, from the point of view of the central bank, the credibility that accrues from a recognized pursuit of inflation stability is invaluable when it comes to addressing the Bank's other preeminent task of maintaining the country's financial stability. Throughout the 80s when crises of many types hit the financial markets, I cannot help but believe that the Fed's demonstrated willingness to take firm steps to pursue the right economic ends was integral to its success in solving those crises. I don't believe I am in any way unique in these beliefs. They are, I think, shared in one way or another by all my colleagues on the Committee. But the power of the Committee is that by including both the regional Reserve Bank Presidents, whether or not they are voting members at the time, and the Washington-based Board of Governors, an umbrella is provided for a wide range of thought and geographic 10 perspective. Forecasts and reasoned, experienced judgements about future economic prospects, and about the variety of regional and financial market reactions are an integral part of monetary policy formation. Such judgements and forecasts form a place to start but they are necessarily surrounded by a cloud of uncertainty. Recognizing this, it is also important to have a wide-ranging, debate about assumptions, and within this debate, more than one geographic perspective, more than one school of thought, more than one econometric model can make a valuable contribution. Ultimately, monetary policy formation ends up being a process of exercising judgement, with very few clear-cut rights or wrongs. The Committee has to make a call, and to do so we have to listen and learn from each other. In addition to providing a forum for different schools of economic thought to flourish and interact, the Committee discussion also provides insight into economic conditions in each region. A region's economic experience can differ quite markedly from the national average and these differences can provide an "early warning" of developments that could affect the nation as a whole. A case in point is the New England experience during the 80s and early 90s. I am told 11 that Frank Morris, then President of the Boston Fed, was a voice in the wilderness regarding the problems inherent in the excess of real estate lending in the mid-80's. This fueled a sizeable economic boom in New England, but the recession that followed was much deeper than the national downturn. The combination of a declining economy and a collapsing real estate market led to severe problems at the region's banks. As banks struggled to survive, they cut back their lending, which further exacerbated the regional recession. New England's problems helped the Committee to understand and manage the dynamics of the national economic adjustment process taking place--an adjustment from a highly leveraged, over extended economy to one that has performed well in the aggregate over the last several years. I believe the Federal Reserve System was designed in a particularly farsighted way in investing real authority and responsibility to its regional Banks. This not only facilitates contact with local business conditions, and different schools of economic thought, but allows each Bank to develop its own unique character that can persist over time, notwithstanding the most recent fad out of Washington, Wall Street, or academia. The existing set-up embodies a unique and 12 effective form of independence for the nation's Central Bank from day- to-day politics that, through the Reserve Banks in particular, I believe is deeply rooted in the public interest. In closing, let me turn to near-term prospects for the economy as I see them. As I noted earlier, we are experiencing one of the longest periods of sustained growth, low inflation, and low unemployment of the entire post-war period. Indeed, one has to go back to the 60's to see periods of similar success. Yet I must say its hard to convince people things really are pretty good. The mood of the country seems to be uncertainty, fed in large part by the well-known, and much discussed trends of technological change, global competition, and corporate restructuring. Feeding into this mood of uncertainty has also been the seeming bumpiness of economic data. Early in 1995, we thought we were looking at a recession; by third quarter there was a remarkable bounce back; in fourth quarter and early '96 more doom and gloom; and then first quarter 1996 GDP came in stronger than expected despite Government shutdowns, blizzards and strikes. It feels like we've been on a roller coaster, but is this in fact the case? 13 What we have been seeing is the effect of rather large variances in inventory accumulation from quarter to quarter. If you take these fluctuations out, and just look at final sales, things seem a whole lot smoother--some variances from quarter to quarter for sure, but over the last 18 months or so a rather stable pattern of growth in the range of 2-2-1 /2 percent. This has been propelling the economy forward, and while higher long term interest rates, a higher exchange rate, and rising levels of consumer debt may act as brakes, particularly toward the last half of the year, my best guess is that the economy's forward momentum, fueled by buoyant financial markets, low unemployment rates, overall growth in personal income, continued business investment, and relatively good levels of consumer confidence, will continue. Most forecasters see second quarter as stronger than first (in part because of yet another inventory swing) but then a gradual slowing to bring the year in at about potential. Price and wage pressures have been well contained, but here a good deal of vigilance is required. The risks of inflationary pressure have increased, but with a great deal of care--and some luck--my hope is we will be able to extend this period of balanced, low inflationary growth.

Cathy E. Minehan (1996, June 18). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19960619_cathy_e_minehan

@misc{wtfs_regional_speeche_19960619_cathy_e_minehan,
  author = {Cathy E. Minehan},
  title = {Regional President Speech},
  year = {1996},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19960619_cathy_e_minehan},
  note = {Retrieved via When the Fed Speaks corpus}
}