STRICTLY CONFIDENTIAL (FR) CLASS I-FOMC

Materials for Staff Presentation to the Federal Open Market Committee

Economic and Policy Implications of Exchange Rate Adjustments
November 4, 1985

Exhibit 1

Foreign Exchange Value of the U.S. Dollar
Quarterly

- points centage
-

Weighted Average Dollar ited

March 1973=100 160 150

140

-

October ober

130
120

-

110

Rate Differential*

100
90

.

-

80 70

1
373

I
1975

I

I
1977

I

I
1979

I

I

I

I
1983

I

I
1985

I

I
1987

I

I
1989

I

1981

r-

March 1973 = 100 - 160 150 140

I30
I20

110

I00

90 80 70

*Difference between long-term government bond yields of the U.S. and a weighted average of other G-10 COUntrieSpiUS Swnzeriand, minus the difference between 12-quarter centered U.S. and foreign inflation rates at annual rates.

Current Account Balance

-

Billions of dollars

-

20

-
-
-

-

40

-

80

- 120

-

-

I
1973

-

180
I
I
1975

I

I
1977

I

I
1979

I

I

I

I
1Q83

I

I
1985

I
1987

I

I

I

1989

1981

Exhlbll 3

U S Net International Investment Position ..
End of Year

Billions of Dollars
1950 1960 1970 1980 1984 1985 13 45

Percent of GNP
4.5 8.9 5.8 4.0 0.1

58
106 28

- 63

- 1.6

1990

With Unchanged Dollar With Gradual Depreciation With Rapid Depreciation

- 700

- 550
- 200

- 13.0 - 10.0

- 3.5

Exhiblt 4

Global Current Account Balances
ars
1980.82
1085 Projected (Second bar)

80

40

+ 0

40

Other OECD

Ten Major Borrowing Countries*

Other DeveloDinc . Countries

80

20

United States

r I

Billions of Dollars
Impact of one percentage point higher dollar interest rates on the net interest payments of: All developing countries, of which:

3
2%

Ten major borrowing countries' OPEC

- 3/4

' Includes Argentina, Brazil, Chile, Colombia, Korea, Mexico, Nigeria, Peru,
Philippines, and Venezuela.

Exhibit 5

Current .Account Balances of Major Industrial Countries
1985 Projected

Japan

Germany

Netherlands

T

Switzerland

United Kingdom

Canada

Exhibit 6

U.S. Real Net Exports by Sector
Finished Manufactures

Industrial Supplies and Materials

1973

1975

1977

1979

1981

1983

1985

Food and Agricultural Products
Billions of 1972 dollars

10

+ 0
10

1973

1975

1977

1979

1981

1983

1985

Exhlblt 7

Composition of Current Real GNP and Hypothetical Real GNP Scaled to 1985 Magnitudes
Billions of 1972 Dollars

Staff Estimate' 1985 (1) 1. Gross national product (C I+ G X - M)

Hypothetical ExampIe (2)

Percentage Change (3)

+

+

1679 1711 1392

1679 1634 1315
44

0

2. Gross domestic purchases (C+I+G) 3. Gross private domestic purchases (C+ I)
4. Net exports

- 4%

-5%

(X- M)

- 33

1. Staff estimate for 1985 in 1972 dollars (October Greenbook).

txnmn 8

Real GNP and Gross Domestic Purchases
Br

8

6

4

2

+
2

0
-

Manufacturing Capacity Utilization Rate

r I

Percent
1973 Peak

85

80

75

70

I
1970

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I
1

1975

1980

1985

Exhlbit 9

Demands on and Sources of Net Saving
Billions of Current Dollars

Staff Estimate' 1985 (1)

Hypothetical Example (2)

Demands on net saving
1. Net private investment
2. Federal budget deficit 223 194 169 194

Sources of net saving
3. Net domestic nonfederal saving 4. Net foreign investment 298 119 363

0

Memo:

5. Personal saving rate
1. Staff estimate for 1985 in current dollars (October Greenbook).

4

6%

Personal Saving and Net Domestic Saving
Percent of GNP Percent of disposable income
7

-

8-

6-

- 88 - 77
6

5

4 1954 1959

1964

1969

1974

1979

1984

1989

*Net domestic nonfedersl saving.

Exhlblt 10

Assumed Paths of Key Variables with a Gradual Depreciation

-

Percent Change; Fourth Quarter to Fourth Quarter

-

1985 1986 1987 1988 1989 1990
1. Real GNP

2.0

2.4

2.7 1.9
4.4

2.7 2.2 4.7 7.0

2.7 2.3
4.8

2.7 2.5
4.8

2. Domestic purchases (C+ I+G)

3.2 1.9
3.6 3.7

3. GNP deflator
4. Treasury bill rate (level in Q4)

7.2 6.5

6.8

7.0

7.0

Key assumptions
Monetary policy: Constant money growth rate (abstracting from shifts in money demand) Fiscal policy: Narrowing of the structural deficit consistent with the objectives of the Congressional budget resolution
5 percent per year depreciation, 1986- 1990

Exchange rate:

Exhibit 11

Impact of a Rapid Depreciation
Real GNP Domestic Purchases

Percent c

I
1985 1987

-

Percent c

I

i

I

1989

GNP Deflator

r

Treasury Bill Rate
Percent CI int

1

1985

1987

1989

9

7

1985

1987

1989

Exhibit 1 2

Impact of a Rapid Depreciation on Spending and Saving
Housing Expenditures Business Fixed Investment
Percent change

r

1

-

Percent CI

e

6

3

1985

1987

19819

Consumption
Percent cl

Personal Saving Rate

f
0 -

3

985

I 987

1989

-

Per, It -

RaDid
-

7

-

3

-

5

-
I

I
1985 1987 1989
1985

I
1987

I

I
1989

I

Exhlblt 13

Risks to the Adjustment Process

.

It may not be physically possible to reallocate sufficient resources to the traded goods sector.

- Bottlenecks and capacity constraints - Labor market shortages
Sharp increases in capacity utilization rates could occur if domestic demand were not crowded out sufficiently. Interest rate effects could be relatively strong because of the sensitive position of many depository institutions. Household borrowers also could be quite sensitive because of high debt burdens and low saving rate. Negative financial market effects could be strong enough to offset the positive trade effect associated with a decline in the dollar.