CONFIDENTIAL (FR) CLASS II-FOMC

Material for

Staff Presentation to the Federal Open Market Committee
February 5, 1980

RlNClPAL ASSUMPTIONS
MONETARY POLICY
Growth of M-1A averages 5 percent in 1980 and 1981

-

FISCAL POLICY
Unified budget expenditures of $563 billion in FY 1980 and $623 billion in FY 1981

No discretionary tax changes during
forecast period

ENERGY PRICES
Oil import prices rise 32 percent during 1980 and 13 percent during 1981

=

Decontrol of domestic crude oil prices continues as scheduled

ONETARY AGGREGATES -

I

I

I

I

I

ITEREST RATES

-

PI

-

Feb. 1

4

1975

I

I

1977

I

I

1979

I

I

1981

EDERAL BUDGET Fiscal Years, Unified Budget Basis 1979 Actual
-

Billions of dollai -

1980 Admin. 564 524 40

1981 Admin. 616 600 16 FRB 623 584 39

FRB
563 520 43

Outlays Receipts Deficit

494 466 28

HIGH-EMPLOYMENT BUDGET -

I

Billions of do1 -

Calendar Years, Unified Budget Basis

LO

20

+

0 -

I

I
1975

I
1977

I

I
1979

I

I
1981

ECONOMIC ACTIVITY
lDUSTRlAL PRODUCTION Index, 1967 I00 -

ONFARM EMPLOYMENT -

Millions of workers

-

Motor Vehicies and Parts

-

I90

-

Total

1

90

170

-

88

150

86

130

-

84

1978

1979

1978

1979

T A I L SALES -

Billions of 1972 I

rs

OUSING STARTS -

Millions of units

Total

1 6

12.25

14

02

1978

1979

1978

1979

REAL GNP

-

1
t

Change from previous p c annual rate, per -

1972 Dollars

LmDlSPOSABLE PERSONAL INCOME mpERSONAL CONSUMPTlON Change from previous period,
annual rate, percent

rEXPENDITURES

1

I
HI
H2

I
HI H2 HI H2

2

1977

1978

1979

Percent

1

HOUSEHOLD DEBT REPAYMENT

I

I
1977 1978

I
1979

REAL DISPOSABLE PERSONAL INCOME

r

Change from previous period, annual rate, percent

1

1975

1977

1979

1981

CONSUMER ENERGY OUTLAYS f As a Percent o Disposable Personal Income

r

Percent

1

I
1975

I
1977

I

I
1979

I

I
1981

REAL PERSONAL CONSUMPTION EXPENDITURES

r

Change from previous period, annual rate, percent

1
5.0
2.5

+
2.5

0 -

I
1975 1977

I
1979

I

I
1981

I

r

DEPOSIT GROWTH AT THRIFT INSTITUTIONS

Change from previous period, annual rate, percent

1

1977

1978

1979

OUTSTANDING COMMITMENTS AT SAVINGS AND LOAN ASSOCIATIONS

r

Billions of dollars

1977

1978

1979

PRICES OF

r

NEW HOMES SOLD

Thousands of units

1

NEW HOMES SOLD -

Percent change, annual rate

1

1977

1978

1979

1977

1978

1979
Millions of units. e. annual

r

HOUSING STARTS

-

-\

.O

Total

.2

I

Multifamily

.4

I
1975

I
1977

I

I
1979

I

I
1981

REAL NEW ORDERS Nondefense Capital Goods

I

7

Billions of 1972 d -

rs

-

13

~

11

9

7

I
1975 1977 1979

I
1981

CAPACITY UTILIZATION

r

REAL BUSINESS FIXED INVESTMENT

Billions of 1972 dollars

1

I
1975

I
1977

I

I
1979

I

I
1981

I

Millions of units

1

I
1975

I
1977

I

I
1979

I

I
1981

I
- 3.5 -

- Dollars, NIA Basis 1972

e-_-e-

-----------

3.3

-

I

I

I

I

I

I
Annual rate, billions of dollars

CHANGE IN BUSINESS INVENTORIES 1972 Dollars, NIA Basis

c

-

20

10

-..

--._ . '----/
e+
~

, /

+
0 10

/-

-

I
1975 1977 1979

I
1981

REAL DEFENSE SPENDING Less Compensation

Change from previous period, annual rate, percent

6
4

+ 0
2

2

-

I
1975

I
1977

I

I
1979

I

I
1981

I

REAL GOVERNMENT* PURCHASES Change from previous period, annual rats, percent OF GOODS AND SERVICES
4

1

+ 0
2

2

-

1 1975

I

I

1977

I

I

1979

I

I

1981

REAL GOVERNMENT* PURCHASES YASHAREOFGNP

Percent

1

1975

I

I

1977

I

I

1979

I

I

1981

*Federal and State and local

kml Nonfarm Employment

r

OIIl Nonfarm Output

Change from previous period, annual rate, percent

1

CIVILIAN LABOR FORCE

r

Change from previous period, annual rate, percent

1
3
2 1

1975

1977

1979

1981

UNEMPLOYMENT RATE

1975

1977

1979

1981

-

UNIT COST INDICATORS Nonfarm Business Sector

-

Change from year earlier, annual rate, percent

\Cormensation

Per Hour

1

I
1975

I
1977

I

I
1979

I

I
1981

PRICES Gross Domestic Business Product

r

Change from year earlier, annual rate. perc

-

It

0

5

I

I

I

I

I

50

30

20

10

+
0

10

1975

1977

1979

1981

PRICES Gross Domestic Business Product

Change from year earlier, annual rate, per1

-

i

2

8

4

1975

I

I

1977

I

I

1979

I

I

1981

Bil ins of 1972 dollars, scale rat -

ION-OIL IMPORTS

Billions of do ars , ratio I ale 240 200

160

120

ac

80

60

4(

-

I
1975 1977 1979 1981 1975

I
1977

I

I
1979

I

I
1981

NONAGRICULTURAL EXPORTS
Bill ns of 1972 dollars, rat scale

OIL IMPORTS
Millions of barrelslday, ratio scale Billions of dollars, ratio scale

-

Billions of dollars, ratio scale

12

80

60

40

+, ,I
____---Volume

1975

1977

1979

1981

1975

1977

1979

1981

*Weighted average againsr G-10 Countries plus Switzerland using total 1972-76 average trade Of these countries.

~

~

~~~

~

~

~~

~

~~

r

MERCHANDISE TRADE AND CURRENT ACCOUNT BALANCES

Billions of dollars

1
**----20

Current Account

'
-

' '

,eO

+ 0

-

/----=- 20 ' ' .'
Trade Balance

I
1975

I

I

I
1977

I
1979

I

I
1981

-

;;--;-------- 120
1972 Dollars

-

---_____--- 100 -

-

80

-

60

I

I

I

I

I

I

I

GNP NET EXPORTS
Billions of 1972 dollars

r

Billions of do

IS

1 0 2 0
10

+ 0

-

10

20

I

1975

I

I

1977

I

I

1979

I

I

1981

FUNDS RAISED BY NONFINANCIAL SECTORS

r

Billions of dollars

1

400

300

200

I
1975

I
1977

I

I
1979

I

I
1981

FUNDS RAISED AS A ERCENT OF GNP -

I
1975

I
1977

I

I
1979

I

I
19e

ORROWING BY HOUSEHOLDS -

Billions of

rs

50

20

80

40

IY13

IYI/

lY/Y

I YC

BORROWING BY NONFINANCIAL CORPORATIONS

c
I

20

80

-

40

1

1975

I

I

1977

I

I

1979

I

I

1981

FOMC Briefing SHA: 2 1 5 m

Thus far--and in large part thanks to the miracle of major

seasonal and definitional revisions in the money supply--money growth, measured by narrow definitions, appears on track with the target for December to )larch set by the Committee at its last meeting. But such a

course now looks as if it will be associated with less ease in credit conditions than might have been expected at that time. Money demands are likely to be stronger in reflection of a revised and less weak staff

GNP projection for the first quarter.

As

a result, should that projection be

accurate, the quite moderate increase in money supply targeted by the Conmittee may entail little, if any, decline in the Federal funds rate over the weeks immediately ahead. But, with economic activity projected to be weaker

in

the second quarter, some further decline in the funds rate is more likely to
OCCUK

in early spring, particularly if the Committee were to encourage

a bit more rapid expansion in M-1A or M-1B in the second quarter than in the first, as suggested by alternative B. But there may also be some question about whether it will in fact be possible to keep money growth to modest proportions over the coming months without exerting upward pressure on the funds rate. Such upward

pressure would be most likely to arise, of course, if the economy strengthens relative to the staff forecast.

In that case upward rate pressure would

appear consistent with the cyclical situation. On the other hand, there are two possible developments that could tend to lead to the seeming anomaly of upward short-term interest rate pressures in a weakening economy, given money growth over the next few months

-2along the a l t e r n a t i v e B path. One would be emergence of g r e a t e r demand W have assumed e

f o r money r e l a t i v e t o income than t h e s t a f f i s p r o j e c t i n g .

t h a t money demand w i l l be weak enough t o permit a b i t s t r o n g e r behavior i n v e l o c i t y o f El-1A and M-1B over t h i s and t h e n e x t q u a r t e r t h a n h a s

u s u a l l y been t h e c a s e i n post-war c y c l i c a l p e a k - t o - t r o u g h

periods.

I n the

p r e s e n t i n f l a t i o n a r y environment t h e p u b l i c i n f a c t may be c o n t e n t t o l e t t h e r e a l v a l u e o f cash b a l a n c e s d e c l i n e s h a r p l y and a t t e m p t t o m a i n t a i n the r e a l value o f wealth--to t h e e x t e n t t h e y can--by, say, acquiring other

p h y s i c a l and f i n a n c i a l a s s e t s t h a t a r e more hedged a g a i n s t p r i c e r i s e s . B u t i f t h e p u b l i c should t u r n o u t n o t t o b e w i l l i n g t o l e t c a s h b a l a n c e s d e c l i n e r e l a t i v e t o income, i n t e r e s t r a t e s would come u n d e r upward p r e s s u r e a n d / o r nominal GNP under downward p r e s s u r e a s t h e p u b l i c a d j u s t s t o t h e c o n s t r a i n e d supply of money. The second development t h a t c o u l d g e n e r a t e upward r a t e p r e s s u r e s o v e r t h e n e x t few months h a s somewhat g r e a t e r odds o f o c c u r r i n g . This

would be t h e impact on money growth of t h e c o n s i d e r a b l e b u l g e , r e l a t i v e to e a r l i e r y e a r s , i n i n d i v i d u a l income t a x r e f u n d s t h a t i s e x p e c t e d t o b e g i n sometime i n l a t e w i n t e r . While we a r e r e a s o n a b l y c o n f i d e n t a b o u t o u r

e s t i m a t e o f t h e amount of t h e s e r e f u n d s , w e a r e q u i t e u n c e r t a i n about t h e e x a c t timing--which depends on t h e s p e e d w i t h which t h e p u b l i c f i l e s t a x p r o c e s s e s them.
W e are

forms and t h e speed w i t h which t h e 1p.s

uncertain
placed

about t h e e x a c t r e s p o n s e o f t h e p u b l i c t o r e f u n d s r e c e i v e d - - w h e t h e r

i n i t i a l l y i n demand a c c o u n t s o r inunediately i n o t h e r a s s e t s , and i f i n demand a c c o u n t s , whether t h e y s t a y o n l y one day
OK

more.

As n o t e d i n thc

bluebook, we would e x p e c t any upward impact o f t h e r e f u n d s on money t o b t temporary--that

i s , i t would n o t r e f l e c t a more permanent s h i f t i n money

demand b u t would be f o l l o w e d i n l a t e s p r i n g and e a r l y summer b y a t e n d e n c y f o r money t o grow s l o w e r .

-3Because o f a l l t h e u n c e r t a i n t i e s i n v o l v e d no advance s p e c i a l a l l o w a n c e was made i n t h e proposed monetary t a r g e t s f o r t h e impact o f t a x refunds. T h e r e f o r e , i f t h e r e f u n d s do i n f a c t t e n d t o r a i s e growth i n

t h e monetary a g g r e g a t e s beyond t h e proposed t a r g e t s , s h o r t - t e r m i n t e r e s t r a t e s would t e m p o r a r i l y come under upward p r e s s u r e - - a p r e s s u r e t h a t would

b e r e v e r s e d l a t e r i n t h e s p r i n g and s u m e r a s t h e flow were i n e f f e c t reversed. However, t h e C o m i t t e e may not w i s h t o s e e i n t e r e s t r a t e s r i s i n g

o v e r t h e months ahead f o r such a r e a s o n , e s p e c i a l l y i f i n f a c t t h e economy

i s weakening.
So f a r a s I can s e e t h e r e i s no e a s y p r a c t i c a l s o l u t i o n t o t h e dilemma posed by t a x r e f u n d s . Deciding t o a d j u s t r e s e r v e p a t h s t o p e r m i t

more money growth t o t h e e x t e n t such growth c a n b e i d e n t i f i e d a s r e l a t e d t o t a x r e b a t e s h a s an a p p e a l , b u t i t i s d i f f i c u l t t o be c e r t a i n t h a t a h i g h e r money growth i n any month i s i n f a c t temporary and r e l a t e d t o t h e r e b a t e s . IJe have had e x p e r i e n c e i n t h e p a s t under a f u n d s r a t e t a r g e t - - a target

t h a t makes i t e a s y t o accomnodate t o t e m p o r a r y b u l g e s i n money growth--where t h e b u l g e i n growth h a s n o t been r e v e r s e d , o r f u l l y r e v e r s e d , and money o v e r t i m e r a n h i g h e r than d e s i r e d . Moreover, i n d e c i d i n g on w h e t h e r t o make a n y

s p e c i a l a l l o w a n c e t h e C o m i t t e e would p r o b a b l y a l s o want t o t a k e a c c o u n t

o f t h e p u b l i c impact of upward a d j u s t m e n t s i n t a r g e t s - - e v e n by no more
t h a n t h e 1 o r 2 p e r c e n t a g e p o i n t s t h a t we now e s t i m a t e t o b e t h e s p e c i a l e f f e c t of t a x r e f u n d s - - a t a t i m e when many i n t h e market h a v e been

~ u e s t i o n i n gt h e r e s o l v e o f p o l i c y , t h o u g h d o i n g s o f o r misguided r e a s o n s .

-4One approach would be t o i g n o r e t h e q u e s t i o n on t h e ground t h a t impacts on money now seem r e l a t i v e l y minor,
OK

i t might b e ignored on

t h e ground t h a t t h e r i s k of p e r m i t t i n g h i g h e r growth i n money c a n ' t be t a k e n

i n t h e p r e s e n t environment.

O t h e o t h e r hand, i f t h e Conunittee wished t o n

a l l o w f o r some temporary i n c r e a s e i n money growth, i t might do so by recognizing--either i n t h e d i r e c t i v e or i n t h e p o l i c y r e c o r d - - t h e

p o s s i b i l i t y t h a t money growth might d e v i a t e t e m p o r a r i l y from t a r g e t i n c a s e o f u n u s u a l l y l a r g e i n d i v i d u a l income t a x r e f u n d s . I f t h e Conunittee d e s i r e d t o make such an a l l o w a n c e , t h e r e a r e a number o f ways t o do so. One way would b e t o i n d i c a t e t h a t t h e Manager need n o t

lower t h e nonborrowed r e s e r v e p a t h o v e r t h e n e x t few months i f t o t a l r e s e r v e s a r e running p e r s i s t e n t l y strong. I n t h a t c a s e , i n t e r e s t r a t e s would p r o b a b l y

r i s e a s borrowing r o s e b u t n o t by a s much a s i f nonborrowed r e s e r v e s were lowered. A much more accommodative approach would be t o r a i s e t h e non-

borrowed r e s e r v e p a t h t o t h e e x t e n t t h a t any b u l g e i n money a p p e a r e d t o r e f l e c t t h e r e b a t e s , a s d e t e r m i n e d b y , s a y , a n a l y s i s of t h e a c t u a l b u l g e i n money compared w i t h t h e a c t u a l t i m i n g o f r e b a t e s . But s u c h an i n t e r p r e -

t a t i o n l e a v e s t h e s t a f f w i t h a v e r y d i f f i c u l t and t i c k l i s h a n a l y t i c problem. A t h i r d l e s s r i g i d i n t e r p r e t a t i o n would b e t o p e r m i t t h e Manager t o b e t o l e r a n t o f a l i t t l e more money growth t h a n f o r m a l l y t a r g e t e d s h o u l d t h a t emerge, and t h e r e was reason t o t h i n k i t was r e l a t e d t o r e f u n d s , w i t h o u t s t r a i n i n g f o r p r e c i s i o n i n h i t t i n g t o t a l and nonborrowed r e s e r v e s t a r g e t s . A f i n a l , b r i e f word MK. Chairman on a n o t h e r p r a c t i c a l problem--

t h e problem of which o f t h e proposed a g g r e g a t e s should b e g i v e n most weight i n a d j u s t m e n t s , i f a n y , t o t h e r e s e r v e p a t h .

On t h a t i s s u e , a t

p r e s e n t , I would s u g g e s t r o u g h l y e q u a l w e i g h t t o M-1A and M - l B ,

so a s t o

minimize t h e r i s k t h a t we a r e n o t o v e r l o o k i n g s i g n i f i c a n t growth i n t r a n s a c t i o n s balances.

I n any e v e n t , a s a p r a c t i c a l m a t t e r , M-1A and M-1B ought

-5t o move c l o s e l y t o g e t h e r under c u r r e n t circumstances.
I would s u g g e s t g i v i n g

M-2 a more s u b s i d i a r y r o l e u n t i l we have more e x p e r i e n c e w i t h i t and w i t h

a s s e s s i n g t h e s i g n i f i c a n c e f o r p o l i c y of changing behavior o f money market funds and o v e r n i g h t R P ' s r e l a t i v e t o u n c e r t a i n s t a f f p r o j e c t i o n s .