IMPORTANT SAINT LOUIS ROUND TABLE CLUB MEETING MONDAY, APRIL 23, 1990 NOON DAY CLUB - COTTON BLOSSOM ROOM ONE METROPOLITAN SQUARE - SUITE 4000

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1 IMPORTANT SAINT LOUIS ROUND TABLE CLUB MEETING MONDAY, APRIL 23, 1990 NOON DAY CLUB - COTTON BLOSSOM ROOM ONE METROPOLITAN SQUARE - SUITE 4000 Cocktails: Lunch: Speaker: 11:45 A.M. 12:15 P.M. THOMAS C. MELZER, PRESIDENT FEDERAL RESERVE BANK OF ST. LOUIS PLEASE REPLY PROMPTLY WITH FIRM COMMITMENTS IN ENCLOSED ENVELOPE

2 INTRODUCTION 1990s Off to Very Strange Start CHART 1: Federal Funds Rate and Treasury Securities * Fed funds rate (- and unchanged) vs other rates(+) since Dec; very different from 1989 pattern. CHART 2: U.S., Japanese and West German Interest Rates * Foreign interest rates have been rising throughout 1989 and into 1990; U.S. rates fell for much of 1989 before rising again since Dec. CHART 2: Foreign Exchange Rates * Exchange rate movements Yen/$ and DM/$ very different in 1990 from 1989 pattern. * Since Feb. $ up against both Yen and DM despite major increases in foreign interest rates. Digitized for FRASER 1

3 CHART 4.: U.S.-German Interest Differential and DM/S Rate I think that the interesting aspects shown here (the behavior in 1990) can be more easily pointed out using the previous two charts. What's It All About? * For analysis of such diverse and puzzling movements, you need a framework for analysis. I 7 11 use one that focuses on impact of U.S. monetary policy on the economy. CHART 5: Ml Money Stock * In last 5 years there has been one obvious major change in monetary (Ml) growth: vs. 87-present. * policy was intended(?) to depress (devalue) the $ in forex markets; 87-present was intended (?) to wring out the inflationary effects produced by the episode. Both periods were characterized by excessive policy actions (first, Digitized for FRASER 2

4 too fast, then too slow). * The same pattern of "excess" can be seen more recently. 2nd half of 88-lst half of 89: Ml growth was too slow result: weakening economy. 2nd half of 89 to present: Ml growth is accelerating possible result?: accelerating inflation. CHART 6: Ml Money Stock With FOMC Dissents * Brief discussion of policy and context of FOMC dissents. * Why have U.S. interest rates risen recently? For two reasons, both related to policy issues. First, Ml growth has accelerated recently ADD RECENT NUMBERS and raised inflationary expectations. Since expected inflation is a key determinant of interest rates, interest rates rose as well. Second, the sharp swings in money growth contribute to greater risks in financial markets because it is increasingly difficult to determine what sort of policy we are following. Since such risk considerations are a key determinant of interest rates, U.S. interest Digitized for FRASER 3

5 rates rise. * If things are so confused here, why has the $ risen recently? Because, believe it or not, things are worse abroad. The sharp rise in foreign interest rates have been produced by inreased inflation and inflation expectations in Japan and Germany. Moreover, increased risks associated with Japanese financial markets and German unification have pushed their rates up as well. When things get confused worldwide, the $ is the usual "safe haven." Where Do We Go From Here? CHART 2: Rates of Growth in Ml * Policy is now at a crossroads. The trend (long-term) growth in Ml tells us what the monetary pressures on inflation are likely to be. We've reduced this inflationary influence significantly in recent years. If we can gradually reduce it further (to about 1 to 2 percent), we would approach a goal of stable prices and win the inflation battle. Doing so would reduce U.S. interest rates and add to the Digitized for FRASER 4

6 stability of U.S. financial markets. actually do it? Will we * We are in for a period (perhaps extended) of slower economic growth Partly in response to slow Ml growth in early 1989 and partly because what is termed the "natural" rate of real growth is only about 2 to 2.5 percent. If we attempt to accelerate real growth by faster money growth, we'll lose the inflation battle. * There are repeated calls for further devaluation of the $, largely in an attempt to increase our exports. Such attempts are usually misguided because they fail to distinguish between movements in real vs. nominal exchange rates. If we attempt to drive the $ down by faster money growth, we'll lose the inflation battle. * There will be increasing calls for us to "ease" the burdens that Japan and Germany may have to face in reducing their inflationary pressures and other economic problems. One way to do this would be to "speed up" our economy to encourage more imports from these economies. we attempt to ease their "burdens" by faster If Digitized for FRASER 5

7 U.S. money growth, we'll lose the inflation battle. Digitized for FRASER 6

8 Federal Funds artel Treasury Securities Yield Percent b F M A M J J A S O N D J F M A

9 Irhterest Routes U.S., Japan, and West Germany Percent 10.0 i Q I I I I I I I I I I I I I I 1 F M A M J J A S O N D J F M A

10 FoTexg n EoccHoLTige Rates: DM/f and Yen/$ DM/$ 2.05 Yen/$ F M A M J J A S O N D J F M A

11 U.S. rnxnvis German Interest 8c EaccHange Rates Percent 3.0 DM/$ F M AM J J A S O N D J F MA

12 Money Stock (M1) Ratio Scale Billions of Dollars \ \ I : I :J S I -' : :'. 1 :;- i - : ' ill 1 M l ) I

13 Money Stock (M1) Ratio Scale Billions of Dollars F0M. C JPOii-cij Di-ssent ' l a i i i i i i i i i i i m i i i i i i i i i i i I I I I I I I H I I i i i i i T

14 Rates of CHange of Money Stock (M1) Percent t. a T i e T.R a, ie of Ch a, n ae - Q ii. <x T i e T JRciie o. f Ch a?% ge

15 Federal Funds and Treasury Securities Yield Percent 10.0 J C1 f; :b 1 7~1 _ '_A. _i i_.mds R at, e 9.5.:W" "-".:.-.i:;l : I -,;;-* :-{ ::; \j ~r r~-* - - '. ; -?.r -;!lrrt-.rtree~trrurtrrttf ~~\ L l_ 1 i 1 1,...1,.., I I I 1 F M A M J J A S O N D J F M A

16 Interest Routes U.S., Japan, CLIXCL West Germouny Percent ^ \ ^ u - s J**\ West Germany _^^tm "^ r.".."-"^ _*Vfc_ 5.0 ^^=L- : _-..-;.:::= ' rr=-=.^" v'-t: L i i i i i i i i i i F M A M J J A S O N D J F M A

17 Fonrexgrt EoccHctnge Rates: DM/$ and Yert/$ DM/$ 2.05 Yen/$ FMAM JJA S O N D J F M A

18 Money Stock (M1) Ratio Scale Billions of Dollars i-«>-. j.. i G.8% ::: -,. - <1.-;;: 0- i I 1.6% 1 IB 1 j 1 LJ ill i-1.1 L.J I I I I l l I l l 1 l l l J l l ] li l.i.,llj..i_l ll II 1 M 1 ) M ,

19 Money Stock (M1) Ratio Scale Billions of Dollars T 3 fe,:.?f*^ 4-:^ <": 625 It- 1 1 ': / 'r- pomc Policy Dissents» M»» i i i i i i» l i B» ) i t i i i i i l i M i i i i i i i i i l i i i i i i i» i i i l i i i i i i i i I i i i i i J i i i i i i

20 Rates of Change of Money Stock (M1) i i i i ) i i i r-:l:."eri i i i l i l I 1 1 li i i i i i i i i i J I I i i i i i I i \ i i i I I I l l l» *2 Q u a, r t e r Rate o f Ch a -n gc **72 Qucirte7~ Rctte of Change