Speech

RESEARCH LIBF f Federal Rf^rvf*'Am%3 on delivery E.D.T. of st?l3Aii 9 986 Jul^ '*2-3, 1 AUG 4« Statement by Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing and Urban Affairs United States Senate July 23 1986 f Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis I appreciate the opportunity to report once again on the conduct of monetary policy. I would first like to place that matter in the larger context of the performance of the United States and the world economy. As you know, there have been marked contrasts in the economic performance of different sectors and regions of this country. Consumption has been strongly maintained, and there have been large increases in employment in the broad service sector. Housing is being built at a high rate. But industrial activity and business investment, which had leveled off last year, have declined over the last six months, and the agricultural and energy industries are under strong pressure. As a consequence activity in some areas of the country has advanced rather strongly, while severe adjustments are taking place in the energy and agricultural belts. The net result is that the overall economic growth rate in the United States moderated to about 3 percent through 1985 and early 1986, and apparently slackened further in the second quarter of this year. Moreover, growth in other major industrialized countries remained slower than in the U.S. during 1985 and the early part of this year. Throughout this period, sizable increases in employment have continued in this country; the unemployment rate has remained generally at a little over 7 percent and, relative to the size of the working age population, more people are employed than ever before recorded. In Europe, unemployment has also remained relatively steady, but at much higher levels. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- After more than three years of economic expansion, the process of disinflation has continued, reinforced for the time being by sharply lower prices of oil, by far the most important commodity. With industrial prices steady/ the average level of wholesale prices has been declining here, and even faster in key countries abroad whose currencies have been sharply appreciating relative to the dollar. Interest rates here and abroad have also declined appreciably, reflecting both the sense of progress against inflation and the fact that growth has been proceeding well within capacity restraints. The large decline in U.S. interest rates and the sharply higher stock market over the past year suggest the cost of capital has declined. The fall in oil prices has helped bolster the real income of consumers. Meanwhile, the substantial depreciation of the dollar has placed our industry in a decidedly better competitive position vis-a-vis other industrial countries. As many have suggested, these underlying forces should help sustain an economic expansion that has already lasted longer than most. But I would be remiss in failing to emphasize much less satisfactory aspects of the U.S. and world economic situation. There can be no evading the fact that some funda- mental economic adjustments must be made within our economy in the months and years ahead. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- The clear challenge is to find the ways and means to work through those adjustments in a context of sustained growth while also consolidating and retaining the progress toward price stability. The conduct of U.S. monetary policy is obviously relevant to that process. But that single policy instrument cannot itself provide the answer. Complementary approaches in the fiscal, trade and other policies of this country, and in the approaches of other countries will be required as well. f The hard fact is that, while the need for complementary actions to achieve the necessary adjustments in the United States and world economy seems to be more widely recognized, progress in coordinating action toward those aims has been limited. Disequilibrium in the Industrial World Some obvious imbalances have developed in the economies of the industrialized world. That is evident most of all in the enormous deficit in our external trade and current accounts, and in the counterpart surpluses of a few other countries. Unless dealt with effectively and constructively, growing market and political pressures will, sooner or later, inevitably have much more disturbing consequences. The problem first clearly emerged some time ago. The powerful thrust of the strong U.S. economic expansion in 1983 and 1984 had spilled out abroad in the form of sharply rising imports, aided and abetted by the exceptional strength of the dollar internationally. There were, for awhile, benefits on all Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- Europe and Japan to restore and maintain their growth. The United States also absorbed a disproportionate share of the necessary external adjustment efforts by the heavily indebted countries of Latin America. Those countries have sharply curtailed their imports since 1982, and they have become more competitive in markets for manufactured goods. At the same time, the United States began to be the recipient of a growing flow of capital from abroad. That inflow, which pushed the dollar so high in the exchange markets until early 1985, had the practical effect of relieving potential pressures on our internal financial markets even in the face of the massive and growing federal deficit. Consequently, private investment and construction could expand. At the same time, the competitive pressure from imports encouraged strong cost-cutting and productivity efforts in the industrial sector. That has been one powerful factor accounting for the near stability of prices of manufactured goods over the past year or more. We cannot, however, build a lasting foundation for sustained growth and stability on massive international dis- equilibrium — huge and rising trade deficits in the United States and counterpart surpluses abroad. Nor can we count on satisfying indefinitely so much of our own needs for capital by drawing so heavily on the savings generated elsewhere in the world — savings that have been so freely available in part only because internal growth in Europe and Japan has been relatively slow. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- Today the imbalances and strains are clearly showing. The forward momentum of our economy has been sustained almost entirely by consumer spending and housing construction, both of which have been accompanied by unsustainably heavy borrowing. Savings meanwhile have remained at a relatively low level, even by past U.S. standards. For more than a year, industrial production in the United States has not grown appreciably, and there has been some decline in 1986. The pace of business investment has slackened. Some of the relative weakness in industrial output and investment over the past six months can be attributed to temporary factors and to developments peculiar to the United States. For instance, some investment orders were speeded up late last year in anticipation of tax reform, and the debate on the nature of that reform has apparently led to some deferral of ordering this year. The boom in spending for computers has subsided and commercial construction, in response to large and growing vacancies of office space, is predictably declining. Probably much more important in recent months have been very sharp cutbacks in domestic oil exploration and investment, driving energy producing states into recession-like conditions and affecting production of steel and equipment elsewhere as well. But a large part of the difficulty stems from the continuing imbalances in the world economy. On the average, growth rates in major European economies and Japan were about 3/4 percent less than the reduced growth path of the United States Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- during 1985 and the first quarter of 1986. However, the more disturbing contrast lies in the source of that growth. In the United States, the rate of growth in domestic demand, while slowing in the third year of expansion, continued to average about 3-3/4 percent through that period. Domestic demand growth in the industrialized countries of Europe and Japan was significantly less — about 2-1/2 percent. In the early part of this year, when their exports slackened, those countries grew not at all. The plain implication is that our overall GNP growth rate was reduced by continuing deterioration in our trade and current account balances. With our current account deficit reaching a record $135 billion annual rate in the first quarter of this year, industrial production and investment were restrained. Meanwhile, foreign surpluses continued to build through much of the period, and as their exports have slowed, internal demand has not yet, in most of those countries, picked up the slack. Prospects for investment and for manufacturing activity in the United States are heavily dependent on an improved trade outlook. The sharp decline in the dollar since its peak in early 1985 should help set the stage for such an improvement. There is evidence that U.S. producers find themselves in a stronger competitive position. However, the deterioration in actual trade in manufactured goods has slowed little. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- The decline in the dollar is both relatively recent and from a very high level so the absence of a stronger response in trade so far is not entirely surprising. What is of concern is that the domestic markets of our major industrial competitors have remained so sluggish, raising a question as to the buoyancy of the markets for our exports and of their own growth prospects. You are well aware that the present imbalance among industrial countries is reflected in strong protectionist pressures in the United States. Yet, as the President has so strongly emphasized, to abandon our tradition of relatively open markets would surely be to invite an unravelling of the international trading order. We would then have less trade and more inflation. With that, prospects for sustained growth both here and abroad would clearly be placed in jeopardy. I know of the complaints about "unfair11 trading practices of other countries. We need to deal with them energetically. But I also know the clear lesson of Experience is that a protectionist retreat by the United States, the world's leading economic power, would invite recrimination and escalation. Certainly, the most effective and promising avenue for dealing with the trade complaints on all sides will be in the planned round of multilateral trade negotiations rather than in a tit- for-tat process of mutual retaliation. Moreover, I believe it is demonstrable that, as a matter of relative importance, much more fundamental imbalances in the world economy than unfair trading practices are responsible for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -8- the present pattern of trade deficits and surpluses. Those underlying imbalances can only be dealt with by complementary economic policies, not protectionism. Quite clearly it is in no one's interest — not the United States or other countries — that we seek better balance in our external accounts by deliberately restraining further our own growth rate. But it is also true that as things now stand, stronger domestically generated growth in the United States will not reduce the international imbalances. Taken alone, it would aggravate our trade deficit further, posing an even more difficult adjustment problem later. As I suggested, the recent exchange rate changes can help us to escape that dilemma — they should work to improve our trade position and reduce the surpluses of others. In fact, faced with a combination of appreciating currencies and slower growth in overseas markets, exporters in both Japan and some European countries are experiencing reduced profits and more sluggish orders from abroad. However, in the absence of offsetting internal sources of expansion, those same pressures could dampen their own prospects for growth. That is one of several reasons we should not rely on exchange rate changes alone to produce the needed international adjustments in the world economy. Over a number of years, we in the United States will certainly need to shift more of our resources into exports, and into recovering domestic markets where import penetration has been so high. That, very broadly, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis — 9—• implies relatively more growth in manufacturing? relatively less growth in services, in governmental spending, or in other sectors; and more savings and less borrowing. For some of the rest of the world, the opposite shift will need to be at work — less reliance on exports, and more on domestic sources of growth. Much still needs to be done to ease the way for those adjustments. For one thing, we in the United States are not prepared for a really large improvement in our trade balance. Our financial markets remain dependent on the large capital inflows from abroad that are a necessary counterpart of our trade and current account deficits. Moreover, taken by itself, depreciation of our currency in an effort to redress the trade deficit poses a risk of renewed inflation. Only as our huge federal deficit is cut can we comfortably contemplate less borrowing abroad and provide assurance against renewed inflation. Put another way, in a growing economy, reductions in the federal deficit will be necessary to release the real and financial resources necessary to improve our trading position in a way consistent with rising investment. In a few foreign countries, such as Germany, some signs of stronger internal growth have appeared in recent months. But such signs are far from uniform among key countries abroad, and most projections of their growth for this year have been lowered, not raised, as exports have slowed. With rising currencies and falling oil prices, some of those countries after years of effort have now successfully achieved virtual stability in consumer prices. Moreover, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -10- their wholesale prices have declined sharply and are appreciably lower than a year ago. All of us — and certainly this central banker — can appreciate the importance of maintaining a broad framework of stability and appropriate financial disciplines to sustain that progress* What is at issue for some countries is their ability to achieve and maintain vigorous internal growth at a time of high unemployment and ample resources as external stimulus fades away, as it must if international equilibrium is to be restored. The appreciation of their currencies and the strong deflationary influences of low oil and other commodity prices would appear to offer a prime opportunity for reconciling those goals of domestic growth and stability. The International Debt Problem Four years after the international debt problem broke into our collective consciousness in 1982, when Mexico abruptly lost access to international credit markets, that threat to our mutual prosperity remains. The renewed difficulties of the oil producing countries today should not, however, obscure the progress that has been made. Collectively, the heavily indebted countries of Latin America and elsewhere have made an enormous effort to adjust their external accounts? in fact in 1984 and 1985 they were in rough current account balance, in contrast to an aggregate deficit of about $50 billion in 1982. To be sure, that effort for a time was accompanied by sharply lower imports, recession, and lower standards of living as they Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -11- brought their spending more in line with their internal resources. But it is also true that many of those countries are again growing, in some cases with vigor as is the case with the largest single f debtor, Brazil. Helped by the reduction in world interest rates, external interest burdens have been reduced appreciably in some countries relative to exports or other measures of capacity to pay. A number of Latin American countries have also made striking progress in dealing with ingrained inflation for the first time in many years, in the process gaining political support. There has been considerable, if uneven, progress toward liberalizing their economic structures in ways that should encourage more growth and productivity over time. In the midst of this progress, the sharp decline in oil prices over the past six months has had an enormous adverse impact on the oil-exporting heavily indebted countries — Venezuela, Nigeria, Ecuador and Mexico. At current oil prices, for instance, Mexico would lose about a third of its 1985 exports, perhaps as much as 15 percent of its government revenues, and the equivalent of some 5 percent of its GNP. Inevitably, that situation poses a new and severe challenge for Mexico ~ a challenge that will require strong new efforts to make the necessary economic adjust- ments and to improve the structure of their economy. There is no large cushion of external reserves to buffer the shock. Consequently r a large amount of financial resources will have to be marshalled from abroad to help ease the transition* to maintain continuity in debt service, and to provide a solid base for renewed growth. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -12- That combination of adjustment, structural change, and appropriate financing is, indeed, the essence of the approach announced by the Mexican government earlier this week. In cooperation with the IMF and the World Bank, Mexico is under- taking a wide range of efforts to deal with both its short- and longer-range economic problems. To my mind, their efforts in the midst of crisis, to move toward a more open, competitive economy are particularly encouraging. They have joined GATT, import restrictions are being rationalized and liberalized, a good many state-owned enterprises are being made available for sale (or, if too inefficient, shut down), subsidies are being reduced and eliminated, and procedures for approving foreign investment eased. If carried through effectively, those measures promise to work toward fundamental improvement in the efficiency, competitiveness, and creditworthiness of the Mexican economy, thereby enhancing prospects for longer-term growth. Today, that country is in recession. But the program clearly contemplates economic recovery in 1987 and 1988. Certainly, sizable amounts of financing from abroad will be required to support that effort. About half of that can be committed by the IMF, the World Bank, and the Inter-American Development Bank. But Mexico is calling upon commercial banks, with so much already at stake, to play a large role as well. In assessing that situation, I would note that the Mexican exposure of commercial banks appears not to have increased Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -13- for some 18 months. Indeed, there has been little net new lending to Latin America as a whole over the past year. Taking the entire period since mid-1982, the exposure of American banks to the heavily indebted countries of Latin America relative to their capital has declined appreciably. That ratio fell from about 120 percent of the capital of lending banks to less than 75 percent at the end of last year, a decline of 38 percent. No doubt, there has been a further reduction by now. Those exposures, in relative terms, are actually considerably less than in 1977 when the data were first collected. For some time, the pace of lending has, in fact, been well below that contemplated by Secretary Baker when he set out a framework for a growth-oriented approach toward the international debt problem at the IMF meetings last autumn. That initiative — essentially contemplating a combination of strong adjustment efforts and structural reform by the indebted countries with reasonably assured financing by international institutions and private banks — is now being tested. It is being tested in difficult circumstances not foreseen at the time — the sharp break in oil prices. But the basic community of interests among borrowers and lenders — and the world at large — in a coherent, cooperative approach is as strong as ever. The debtor countries themselves have an enormous stake in maintaining their creditworthiness and in seeking solutions in the framework of open, competitive markets. We all have a strong interest in international financial order — all the more when there are other points of strain in the banking system. And, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -14- of course, relationships beyond the purely economic are at stake, for the United States most of all. The challenge is large, but with cooperation, also manageable. Indeed, the same oil price decline that has under- mined the budgetary and trading position of Mexico and other large oil exporters has relieved the pressure on those importing oil. Interest rates have declined. A number of borrowing countries will require significantly less, rather than more, financing than was contemplated a year ago. Given the enormous progress made in adjusting external positions, most of the borrowers can look toward more balanced expansion in their imports and exports as they grow — among other things, providing renewed opportunities for American exporters. But I must also emphasize one essential ingredient for success beyond the capacity of the indebted countries to manage. Only a stable, growing world economy, with markets open to the developing world, can provide an environment conducive to economic expansion, more normal interest rates, and orderly debt service by the borrowers. That ingredient is plainly the responsibility of the industrialized world alone. It is one of the reasons why we must collectively deal with the obvious imbalances among us. Monetary Policy in 1986 These larger issues were the background against which the Federal Reserve has conducted monetary policy in 1986 and reviewed its objectives for growth in money and credit this year Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -15- and next. The results of the review by the Federal Open Market Committee of target ranges for money and credit for 1986 and tentative ranges for 1987 were discussed in the Humphrey-Hawkins Report published and sent to the Committee at the end of last week. That report also sets out projections for real activity and prices of FOMC members and Reserve Bank presidents. As indicated in the Report the posture of monetary f policy remained broadly accommodative over the past six months. The discount rate has been reduced in three steps this year by 1-1/2 percent, in part responding to and in part facilitating declines in short-term interest rates of similar magnitude. Long-term interest rates also moved lower, extending the sharper drops in the second half of last year. The general structure of interest rates is now as low as at any time since 1977. The reductions in interest rates in 1985 and 1986 have clearly helped support the more interest-sensitive sectors of the economy, reflected in part in the highest level of housing starts since the late 1970s. The declines have also helped ease the debt servicing costs of businesses, farmers, developing countries and the U.S. Government itself. On the other side of the ledger, as interest rates have declined, the rate of growth in debt has remained at disturbingly high levels, although there are at least faint signs of a slackening in the rate of debt creation after a burst around the turn of the year. The declines in interest rates also clearly helped induce the general public to increase its holdings of its most liquid assets, including demand deposits and NOW accounts included in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -16- the narrow measure of the money supply, Ml. That reaction was undoubtedly amplified by the fact that interest is paid on NOW accounts, which are now the favored form in which transaction balances are held by individuals. With interest rate spreads currently quite narrow between NOW accounts and other liquid assets, those accounts no doubt have served increasingly as a repository for liquid savings as well as for money held for transactions purposes. Similarly, there are some indications of a greater willingness of businesses to hold demand deposits at a time of lower interest rates, partly because, with interest rates down, a larger balance is necessary to compensate banks for a given amount of services. To some extent, an environment of more stable prices may also be encouraging larger money holdings. None of that was predictable with any precision, and the rate of growth in Ml, which ran at almost 13 percent over the first half of the year, was far above the FOMC's target range. Action to restrain that growth within the target range — which would have required reducing the provision of reserves and a significant increase in pressures on bank reserve positions -- was not deemed desirable in the light of other important consider- ations. One of those considerations was that growth in the broader measures of money — M2 and M3 — remained well within their respective target ranges of 6-9 percent, ending the second quarter close to their mid-points. That and other evidence suggested Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -17- that much of the growth of Ml reflected a shifting of the composition of liquid assets rather than excessive and potentially r highly inflationary, money creation. That judgment was, of course, reinforced by the moderate rate of growth for the economy overall, the absence of indications of a strong acceleration as the year progressed, evidence of greater stability in prices of manufactured goods, and declining commodity prices. In looking ahead, the Committee decided to retain the existing ranges of 6-9 percent for M2 and M3 this year. The range of 3-8 percent set for Ml early in the year was not recalibrated because of the uncertainties as to the behavior of that aggregate at present. Certainly the inflationary potential of excessive money growth remains a matter of concern. But in current circumstances, the Committee decided that the significance of changes in Ml could only be judged in the context of movements in the broader aggregates, and against the background of movements in interest rates and the economy generally. Taking account of those factors, growth in excess of the target established at the start of the year will be acceptable. In circumstances of greater economic, price, and interest rate stability, more predictable relationships between Ml and the economy may reemerge over time, although the trend of Ml velocity — the ratio between GNP and Ml — will likely be different than earlier in the postwar period. However, a firm conclusion concerning the nature and stability of future velocity characteristics may take years of experience in the new Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -18- institutional and economic setting. For the time being, in looking to next year, the Committee set out a highly tentative range of Ml growth of 3-8 percent on the assumption that velocity changes will be within the range of most postwar experience* However, that judgment — and indeed the weight to be given any Ml range for 1987 ~ will be carefully reviewed at the start of next year. The tentative 1987 ranges for M2 and M3 were lowered by one-half percentage point to 5-1/2 - 8-1/2 percent. That modest reduction, consistent with the long-term objective of achieving a rate of monetary growth compatible with price stability, is judged to be entirely compatible with a somewhat greater rate of economic growth next year, provided that growth is not accompanied by a marked increase in inflationary pressures. The actual price statistics for some months have, of course, reflected the precipitous drop in the price of oil, and consumer prices have dropped slightly this year. But equally clearly, the price of oil will not continue falling so fast, and at some point could well rise again. More predictably, the large depreciation of the dollar will bring in its wake an increase in import prices of manufactured goods. That impact has been moderated so far by the narrowing of the earlier wide profit margins of many of those exporting to us and by the availability of imports from developing countries, few of which have had any appreciable appreciation of their currencies vis-a-vis the dollar. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -19- The rate of increase in costs of housing and of many services, which account for a large proportion of the economy, has decelerated little if at all in recent years. With demand strong, measured productivity gains limited, and compensation or increases in service occupations continuing to average 4-1/2 percent or more, those areas continue to lend a chronic inflationary bias to the general price level. Those underlying forces are reflected in the projection of FOMC members and Reserve Bank presidents that the overall inflation rate is likely to be somewhat higher next year. That prospect underscores the need for vigilance in the conduct of monetary policy. We want to assure maintenance of the remarkable progress toward stability as the economy grows more strongly and as a large amount of resources are shifted back to manufacturing industries as our trade balance improves. Without such assurance there would be no firm basis for expecting f the level of interest rates to remain for long at lower levels or to decline further. In looking toward growth in the 3-3 1/2 percent range next year, considerable emphasis was placed by Committee members on the potential contribution to that growth of a stronger trade balance. As I emphasized earlier, that shift, if it is to take place in the context of sustained and stronger world growth, will require appropriately complementary policies here and abroad. Significant progress toward dealing with our own Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -20- budget deficit seems to me a key ingredient in that overall policy "mix." The timing of another important domestic policy instrument — discount rate cuts — has been influenced by international financial and exchange rate considerations. A substantial realignment of the excessively strong dollar exchange rate has been a necessary and constructive part of achieving the necessary adjustment in external trade. But there are clear dangers in placing excessive weight on that approach. History demonstrates all too clearly that a kind of self-reinforcing cascading depreciation of a nation's currency, undermining confidence and carrying values below equilibrium levels, is not in that nation's interest or that of its trading partners. Among other things, such a movement of the dollar now could transmit strong inflationary pressures to the United States and inhibit the free flow of capital from abroad at reasonable interest rates. Moreover, other countries would find it more difficult to sustain their forward momentum. In the light of all these considerations, the discount rate reductions in March and April were timed to coincide with similar changes by one or more other key countries, minimizing any impact on the exchange markets and consistent with the desirability of some reduction in interest rates in the industrialized world generally. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -21- Some Lessons of Recent Experience Experience over the first half of 1986 underscored the difficulty — I would say the impossibility — of conducting monetary policy in current circumstances according to one or two simple, pre-set criteria. For instance, the rapid growth of debt and Ml clearly bear watching because of the potential for aggravating the vulnerability of the financial structure to adversity and because of the inflationary potential. However, the weight of the evidence strongly suggests that Ml alone during this period of economic and institutional transition is not today a reliable measure of future price pressures (or indeed a good short-term "leading indicator" of business activity). The more restrained performance of the broader aggregates, as well as the performance of the economy and prices themselves, point in a different direction. At the same time, pressures on the oil industry, agriculture, and parts of manufacturing and the more general disinflationary process are reflected in strains on some depository institutions. Those strains emphasize the importance of dealing with factors more directly under the control of lenders themselves: excessive leveraging of borrowers and loose credit standards. A broad array of approaches by the supervisory and regulatory authorities has Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ;:y -22- been necessary to deal with the particular points of pressure in a manner consistent with the stability of the entire fabric of financial institutions and markets. The present situation certainly makes all the more pointed the need to provide a stronger sense of legislative direction about the evolution of the financial system over time. There are also urgent specific pieces of legislation before you to permit the FDIC and the Federal Reserve to facilitate interstate acquisitions of failed or failing banks and to supplement the resources of the FSLIC. The difficulties of some financial institutions are one specific example of economic problems that cannot be effectively dealt with by monetary policy alone. It is indeed a strength of monetary policy that it can respond flexibly to changing circumstances. But it is equally true that that single, broad-brush policy instrument cannot, at one and the same time, be called upon to stimulate the economy, protect the dollar, restrain excessive debt creation, and shift resources away from consumption and back into investment, manufacturing and exports — as desirable and important as all those goals may be. Events of recent years have also heavily underscored how cumbersome fiscal policy can be, and the difficulties of achieving political consensus on such matters as tax reform and the appropriate legislative framework for financial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -23- institutions. On an international scale achieving consensus f on appropriate action can be still more difficult. We have nonetheless come a long way toward restoring growt-h and stability in this decade. But my sense is that all that progress is in growing jeopardy unless we act — we in the United States, we in the industrialized world, and we in the world as a whole — in mutually supportive ways. The main directions of that effort seem to me clear enough. The Gramm-Rudman-Hollings legislation is an expression of the sense of urgency surrounding our budgetary effort in the United States. The rest of the industrial world needs to achieve and maintain a momentum of "home-grown" expansion. With strong national and international leadership — and with the cooperation of private and public lenders — a constructive resolution of the economic crisis in Mexico can point the way to a wider resolution of the debt problem in a context of growth. Hard as it may be to carry through on those efforts, that is what needs to be done if the imbalances in the economy are to be effectively addressed. Then we will have a really solid base for sustaining the momentum of growth and the progress toward stability in the years ahead. Certainly, the Federal Reserve will play its part in that effort. ******* Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Paul A. Volcker (1986, July 22). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19860723_volcker

@misc{wtfs_speech_19860723_volcker,
  author = {Paul A. Volcker},
  title = {Speech},
  year = {1986},
  month = {Jul},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19860723_volcker},
  note = {Retrieved via When the Fed Speaks corpus}
}