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US Federal Reserve: 870211StaffState1 | Japanese Yen | Federal Reserve System
US Federal Reserve: 870211StaffState1
held on Februarv 10. 1987
The dollar declined in a series of abrupt bursts since
your last meeting. These sharp downward movements, followed by
periods of relative stability, were closely associated with
market perceptions of a wavering commitment by the U.S.
Administration over the need to take action to stem the dollar's
fall. Although U.S. policy intentions were at times unclear,
many market participants assumed that the United States was
willing to accept or even encourage a decline in dollar exchange
rates as the most politically palatable means of resisting
protectionist sentiments and putting pressure on other countries
to stimulate their economies.
On balance the dollar declined
more than 10 percent against the German mark and nearly 7 percent
against the yen during the intermeeting period. But there were
times when the dollar decline was greater, and when market
participants were questioning what there was in the picture to
In early January, signs of a weakening U.S. economy and
the announcement of a huge November trade deficit focused market
attention on trade issues and called into question whether the
October Baker-Miyazawa agreement remained operative. time, At the same
the Japanese monetary authorities
were overplaying the role of intervention in that accord, and was
not surprised to see the Japanese drawn into intervening so
heavily in the foreign exchange market that their intervention
was yielding diminishing returns. disappointed by the lack of expansionary fiscal policy actions in the Japanese budget for the fiscal year beginning in April. As a
result the commentary coming out of Tokyo pointing to the adverse effects of a renewed decline of the dollar against the yen had little echo in the commentary coming out of Washington. Consequently, Japanese investors in dollar denominated securities became all the more concerned that action would not be forthcoming to keep the yen from appreciating. A number of them rushed to cover their currency exposures, thereby adding to the immediate exchange market pressures. In Europe, as the mark strengthened against the dollar
in early January, pressures built up within the European monetary
system (EMS) and all of the partner central banks intervened
heavily to support the EMS parities. The Bundesbank was also
seen purchasing dollars in modest amounts, but most market
participants interpreted this intervention as aimed simply at
preserving the EMS exchange rate parities until after the German
elections. Few in the market expected the Bundesbank to support
In the event, an EMS
the dollar once the EMS was realigned.
realignment occurred over the January 10 weekend.
with the market sensing that the dollar was more vulnerable after
the realignment, news reports stating that the Administration
wanted a lower dollar triggered heavy dollar selling. The dollar
fell by'more than 3 percent in a matter of hours to trade as low
as DM 1.82 against the German mark and yen 151.60 against the Japanese yen. Dollar exchange rates moved down sharply on three other
occasions after mid-January, as market participants interpreted
various press statements attributed to Administration officials
as indicating a lack of concern about the possible ramifications
of a continuing fall in the dollar.
On January 19, the
yen/dollar rate declined after a U.S. news magazine reported that
the U.S. Treasury saw lower dollar exchange rates as appropriate.
On January 22, market participants expressed disappointment that
a new Baker-Miyazawa consultation on exchange rate matters the
pervious day did not lead to any specific announcements of steps
to stabilize the dollar. The dollar also succumbed to heavy
selling pressures on the morning of January 28, moving down
sharply in Asian and early European trading, as the market
interpreted the lack of any reference to the dollar in the State
of the Union message as tacit approval of a declining dollar.
The Foreign Exchange Trading Desk had been prepared to intervene in yen on a modest scale on the days immediately following the Baker-Miyazawa consultation if the dollar moved close to the Y 150 level. With the dollar moving down decisively
towards that level on the morning after the State of the Union message, the Desk purchased $50 million against the sale of yen in an operation coordinated with the Japanese monetary authorities. The U . S . operation was financed equally from Federal Reserve and Treasury balances.
Subsequently, renewed reports of preparations for a
meeting and market talk of the U.S. intervention helped lift the dollar to recover from its lows. Market participants also
interpreted the U.S. intervention as a sign that the Administration could be concerned enough to take further action if the dollar's decline became too rapid. Moreover, dollar
exchange rates gained some underlying support from the announcement at the end of January of a reduction in the U . S . trade deficit and a continued flow of relatively good statistics on U.S. business activity during the past two weeks. The market remains nervous. It is preoccupied with
talk of a G-5 meeting and with the question of whether a way will
be found to fit together the policy actions of the United States
and our major trading partners so as to diminish the global
economic imbalances. Market participants note that Secretary
Baker's comments on economic policy moves in Germany and Japan
now appear to be less confrontational, and he was reported last
week to be in agreement with Chairman Volcker on the dangers of a
too rapid decline in the dollar. Also, the Administration is
reported to be relieved that the trade bills recently presented
to Congress seem to be less extreme than those talked of last
year. At the same time the Secretary's comments on Monday
suggested that not enough progress had been made on the policy
issues to warrant a meeting of high level economic policy
officials, and that caused another abrupt decline in the dollar.
During the intermeeting period, the FOMC subcommittee
on foreign exchange, consisting of the Chairman, Vice Chairman
Corrigan and Governor Johnson, conferred to review the daily
foreign exchange operations limits. The current limits on
foreign exchange operations for a single day, as well as since
the previous FOMC meeting, were reviewed and deemed appropriate.
February 10-11, 1987
The period since the last meeting of the Committee has been marked by unusual money market pressures and reserve demands. These pressures were noticeable in early December, reached a sharp crescendo in the days surrounding year-end and then largely subsided though with some milder outbreaks that have extended well into the new year. The major underlying force was a huge
demand for credit in the final weeks and days of the year, much of it apparently related to an urgent push to consummate various financial transactions before new tax laws took effect. Deposit
growth, especially demand deposits, surged hand-in-hand with bank credit expansion creating insistent demands for reserves. The
very pace of newly rising demands entailed a volume of activity and uncertainty that also boosted demands for excess reserves to record levels. After the turn of the year, a big chunk of the
demand deposit expansion reversed, although bank credit expansion has been considerably slower to unwind, and even the abatement in deposit growth has left narrow money measures showing very substantial growth. Thus M1 was up at more than a
annual clip for December and January combined, using the new benchmark and seasonal revisions. aggregates grew at about a
The broader monetary
to 9-112 percent rate in those two
months moderately ahead of the Committee's preferred 7 percent pace as Ml's surge was tempered by more modest growth in
nontransaction components.
Through this period, the Desk was aiming, as instructed, for
approximately unchanged reserve pressures, as were expected to be
associated with the $300 million level of adjustment and seasonal
borrowing used in constructing the nonborrowed reserve path. In
effect, the normal procedures for holding conditions unchanged-­
including what by past standards were reasonably flexible
approaches to accommodating enlarged demands for required and
excess reserves--were overwhelmed by events. In the course of
the December 31 reserve period, day-to-day upward revisions to
required reserves raised the reserve path by an unprecedented
$1.7 billion, much of it late in the period, while excess
reserves bulged to over $2 billion--far ahead of the already
enlarged $1.4 billion allowance.
As it turned out, not all of
that $2 billion excess was really "wanted.11 By the tail end of
that reserve period, we had pretty much discarded the usual
guidelines and provided reserves based essentially on "gut
feeling," with the result that the final day's provision on
December 31 was overdone and Federal funds traded all the way
down to zero after touching as high as 30 percent that morning.
By some standards, one could regard the emergence of
substantial year-end reserve pressure a8 a fault to be corrected,
although another view would hold that the emergence of
significant frictions and pressures in the face of such an
upsurge in demand was not entirely inappropriate.
Some moderate reserve pressure, foreshadowing the year-end,
was showing through even in the first half of December, when funds averaged about 6-118 percent even though borrowing was fairly light at about $200 million. In the December 31 period,
replete with year-end distortions that saw substantial funds trading in the high teens,
or 30's, funds averaged 7-314
percent and borrowing bulged to about $900 million--with excess reserves, as noted, pushing above $2 billion. Pressure gradually
subsided in early January, producing about a 6.80 percent funds rate in the January 14 maintenance period, or more like 6-114 if one excludes January lst, while borrowing fell back to just under
The average funds rate fell further to 6.07
percent in the January
period but borrowing rebounded to some
$460 million, partly because excess reserve demands again pushed
above the amount allowed for.
As the current reserve period
began in late January, funds were in fairly strong demand again, often in the 6-1/8-1/4 area. This may have reflected the impact When those balances fell
of high Treasury balances at the Fed.
back in early February, funds returned to around 6 percent and briefly a bit under, but the last couple of days have seen renewed pressure with funds back to about 6-114 percent--for reasons that are not yet too clear. Meantime, borrowing in the
current period has been light, averaging about $165 million through yesterday. There is a real question as to whether funds will tend to
return, in time, to the 5-718 percent area that seemed to be
associated with a $300 million borrowing level prior to the onset
of year-end pressures.
In fact, one has to go back to last
October to find a full reserve period average funds rate as low
as 5-718 percent. My own expectation for funds, with $300
million of borrowing, would tend to center now on 6 percent
rather than something a bit under. One possible reason for a
slight shift is the light level of seasonal borrowing--around $35
million in January and a still moderate $50-60 million in the
current reserve period as compared with $100 million or so a few
months ago. Also, the same factors that produce light seasonal
borrowing now may be giving rise to light borrowing needs by
smaller banks, leaving a bit more of the "borrowing gapr1 be
to filled by the larger banks that are perhaps husbanding their use
of the window more carefully.
As would be expected, given the sometimes turbulent reserve
picture, the Desk was quite active during the intermeeting period. The basic contour was one of very large reserve needs
through early January and then an over-abundance of reserves as market factors--notably currency and required reserves--reversed course.
As had also occurred a year earlier, high Treasury
balances in the latter part of January altered the normal timing, tending to delay the typical early-in-the-year excesses until early February. From the start of the period until nearly the middle of January, the System continued to buy bills from foreign accounts, taking a total of nearly
billion. By January
the System began selling bills and in a few cases short-term notes to foreign accounts, in amounts that cumulated to about
In addition, the System ran off
bills and $110 million of agency issues, and sold about $1.5 billion of bills in a market go-around. Outright holdings thus
declined a net of about $2.7 billion on a commitment basis. Substantial use was made of repurchase agreements throughout the period, especially in the days surrounding year-end. Total repurchase agreements, including System and customer related transactions, exceeded $100 billion for the period. December 31 alone, the Desk arranged over
billion of two-day
repurchase agreements, and given the large amount already on the books from previous multi-day agreements, the total outstanding at year-end was a record $16 billion. Notwithstanding the sharp reserve pressures of the
intermeeting period, net interest rate changes over the full
period were moderate. To be sure, very short-term rates climbed
sharply around year-end, particularly as they were affected by
high financing charges. Quoted rates on items such as one month
commercial paper or CDs shot up in thin markets, by as much as a
couple of percentage points, but they dropped back quickly, too.
By the end of the period, rates on private short-term instruments
were little changed from those at the start of the period.
Treasury bill rates rose moderately over the period, especially in the last few days, climbing about 20-30 basis points for key bills over the full interval. The rise, which occurred despite about
billion of net paydowns by the
Treasury, seemed to reflect higher financing costs, as well as
the fact that bill rates in December had been held down to some
degree by year-end window dressing demand. Bills showed little
of the year-end rate bulge exhibited by other short-term
instruments. and +month In yesterday's regular auctions, the Treasury's 3-
issues were sold at about 5.72 and 5.69 percent.
This compared with 5.55 and 5.58 percent just before the last
At mid-day today, the new three and six-month issues
were trading around 5.80 percent in some further reaction to firm
In the Treasury coupon market, there were various
crosscurrents that left yields modestly higher on balance--about
5-15 basis points for key issues.
Working toward higher yields
were the firming of oil prices, the mainly positive numbers on
the economy, the weakness in the dollar, which gave rise to
doubts about the strength of foreign interest in the Treasury's
mid-quarter financing and to questions about inflation prospects,
and most recently the renewed firmness in money rates. On the
other side, broad price measures remained subdued, and the
reported fourth quarter GNP estimate suggested continued
sluggishness in the economy. Periodic partial rebounds of the
dollar, notably after the preliminary December trade figures were
reported, and in response to recurrent speculation about a G-5
meeting, and actual or anticipated actions by foreign authorities
to bolster their economies, also helped the market at times.
Another favorable factor was the sense that Treasury cash demands
have been less than anticipated in recent months.
demand on the coupon market came to about
period, including $15 billion in the quarterly financing that settles next Tuesday. Foreign demand, notably from Japanese
firms, turned out to be pretty strong in that financing, but much of the issue still apparently remains in dealer hands and is contributing to some heaviness in the market yesterday and today. The new issues are currently quoted at discounts yielding about
5-10 basis points also.
for the current market view of policy and interest rate
prospects, that, too, is marked by crosscurrents. , The predominant view of two months ago, looking for more Fed accommodation in the next few months against the background of weak economic expansion, still has adherents but their ranks have dwindled. Increasingly, observers are questioning the need for, Some even see rates
or likelihood of, greater accommodation.
rising in the months ahead.
Specifically on the Fed funds rate,
all through the December and post year-end period many market analysts spoke confidently about funds returning to around 5-718 percent once technical pressures had passed. Some still cling to
this view, having extended their timetable for seasonal pressures. More participants now seem reconciled to a range
centered on about 6 percent, and some are wondering if rates a bit above 6 should not be expected routinely.
During our presentation this afternoon we will be referring to the package of charts distributed to you. The first chart displays the principal assumptions that underlie the staff's economic and financial projections, which for this meeting o f the Committee we have updated and extended through 1988. For monetary policy, M2 is assumed to grow at
around the middle of its tentative long-run range for 1987,
i.e., about 7 percent, and a little slower in 1988. In the
context of our overall projection, it is thought that both
short- and long-term interest rates are likely to be little
changed from current levels through the summer but drift a
bit higher late this year and in 1988.
The fiscal policy assumptions entail further deficit-reducing actions amounting to about $25 billion. Other assumptions involve the foreign exchange value of the dollar, which depreciates further from current levels, and the price of oil which is assumed to average around $17 per barrel over the projection period.
The second chart provides additional information on
the federal budget. In FY 1987, both the staff and Admin­
istration figures point to a sizable reduction in the
deficit compared with the record set in the previous year.
The deficit is projected to decline further next year,
although the staff estimate is well above the Administra­
tion's $108 billion deficit that was fashioned to meet the
Gram-Rudman-Hollings target--a target that in practice is
not a binding constraint.
The Administration's budget contains more deficitreducing actions than we believe will occur. As the middle panel indicates, the $25 billion of actions in the staff figures are less than in the Administration's budget, but roughly comparable to the actions taken in FY 1987. These
data do not include the effects of tax reform, which it is believed will add about $12 billion to receipts in the current fiscal year and lose a few billion in fiscal 1988. Even when one strips out the asset sales, the
federal budget this year has been set on a course of
restraint and we assume that will continue next year. As
shown in the bottom panel, the ratio of the high employment
deficit to potential GNP reached its high last year and
should decline moderately over the projection period.
The next chart presents some indicators of recent economic activity. Nonfarm payroll employment, the top left
panel, expanded at a healthy rate during the second half of last year with manufacturing employment improving in the fourth quarter. The January rise in employment was outsized
and to an extent reflects seasonal adjustment problems;
however, a generous allowance for such difficulties still
leaves a good start for the quarter. Aggregate hours worked
rose appreciably and it appears that industrial production-­
the right panel--rose about 112 percent in January,
extending the gains registered last quarter.
In the automobile market--left middle panel-­
domestic auto sales through November bounced around in
response to the on-again off-again sales incentive programs.
Sales during December were boosted by tax related purchases
and then fell in January to less than 6 million units at an
annual rate. The right middle panel displays real
consumption excluding autos; such spending slowed during the
second half of last year at a time of strong auto sales on
average and declines in real disposable income. for January is not yet available. Information
Housing market activity,
bottom left panel, accelerated late in 1986. Total home
sales shot up in December, partly reflecting tax reform
factors, and starts rose after declining fairly steadily
since the spring. Business equipment spending generally has
been lackluster in recent quarters. The bottom right panel
shows that new orders for nondefense capital goods have
picked up over the past several months, although this has
reflected increases in the aircraft sector where lead times
are fairly long. On balance, our forecast for the current
quarter indicates real GNP expansion of 2-114 percent at an annual rate, although, if we had had the January employment data in time, we would have been inclined to nudge the figure somewhat higher. The next chart presents the broad aggregates in the staff forecast. Real GNP growth is projected at 2 - 3 1 4 percent for this year and next.
that growth is projected to come from the performance of net exports while domestic demands grow less rapidly than in
1986. Prices as measured by the GNP deflator, shown in the
middle panel, are projected to rise faster in 1987 and 1988 than last year. The unemployment rate in the forecast moves marginally lower to end at 6 - 1 / 2 percent. Mr. Truman will continue the presentation.
E.M. Truman February 10, 1987
The upper panel i n Chart 5 provides a p e r s p e c t i v e on t h e U.S. d o l l a r ' s f o r e i g n exchange value over t h e p a s t 15 years. The r e d l i n e
shows t h e p r i c e - a d j u s t e d v a l u e o f t h e d o l l a r a g a i n s t t h e o t h e r 6-10 c u r r e n c i e s - - t h a t i s adjusted f o r r e l a t i v e consumer p r i c e levels--from 1973 t o date. As can be seen, t h e d o l l a r ' s movements have been l o o s e l y and f o r e i g n r e a l long-term
c o r r e l a t e d w i t h t h e d i f f e r e n t i a l between U.S. i n t e r e s t rates.
That d i f f e r e n t i a l has been d e c l i n i n g s i n c e t h e m i d d l e
of 1984 and i s now negative, where i t i s expected t o remain throughout
t h e f o r e c a s t p e r i o d and have a c o n t i n u i n g depressing e f f e c t on t h e d o l l a r f o r some p e r i o d o f time. Meanwhile t h e d o l l a r has depreciated
almost 40 percent i n p r i c e - a d j u s t e d terms against t h e o t h e r G-10 c u r r e n c i e s s i n c e i t s peak i n t h e f i r s t q u a r t e r o f 1985. The d o l l a r ' s
d e p r e c i a t i o n i s p r o j e c t e d t o continue, a l b e i t a t a reduced pace, a t l e a s t through t h e end o f 1988. Against t h e currencies o f e i g h t o f our
o t h e r major competitors i n L a t i n America and Asia, t h e d o l l a r has appreciated i n r e a l terms on average by about 3 percent over t h e p a s t two years. However, we a r e assuming t h a t t h e d o l l a r w i l l depreciate
a g a i n s t those c u r r e n c i e s b y about 2 percent over t h e f o r e c a s t period. The lower panel p r o v i d e s a longer-term p e r s p e c t i v e on t h e U.S. c u r r e n t account scaled b y
Although over t h e p a s t two years
t h e d e t e r i o r a t i o n has slowed somewhat, t h e c u r r e n t account d e f i c i t has p e r s i s t e d s u b s t a n t i a l l y o u t s i d e t h e h i s t o r i c a l range.
p r i m a r y reason why we a r e p r o j e c t i n g a f u r t h e r d e p r e c i a t i o n of t h e
dollar. The d o l l a r ' s a c t u a l and p r o j e c t e d d e p r e c i a t i o n are expected t o c u r r e n t account d e f i c i t t h i s year; b y t h e end
begin t o reduce t h e U.S.
o f 1988, t h e adjustment i s expected t o amount t o a b i t more than 1 q e r c e n t o f GNP, which would be a somewhat smaller and l e s s abrupt adjustment than occurred i n 1978-79. Turning t o t h e next chart, progress against i n f l a t i o n both here and i n other i n d u s t r i a l c o u n t r i e s was helped along i n t h e past year o r so b y d e c l i n i n g o i l p r i c e s and t h e r e l a t i v e s t a b i l i t y o f d o l l a r p r i c e s o f other commodities. However, t h e d e p r e c i a t i o n o f t h e d o l l a r
has meant t h a t these trends have been magnified i n t h e other i n d u s t r i a l countries. Consequently, as i s shown i n t h e upper l e f t - h a n d panel, i n
1986 t h e d e c l i n e i n wholesale p r i c e s abroad averaged about t w i c e t h a t i n t h e United States. The r e d l i n e i n t h e right-hand panel shows t h a t
commodity prices, as measured b y t h e Economist index, have continued t o d e c l i n e i n f o r e i g n currencies even as they have s t a b i l i z e d o r turned up s l i g h t l y i n d o l l a r terms. The lower panel shows t h e p r i c e o f U.S. imported o i l and, f o r Both p r i c e s import
reference, t h e spot p r i c e o f West Texas intermediate crude. moved up toward t h e end o f 1986.
W are p r o j e c t i n g t h a t t h e U.S. e
p r i c e w i l l drop back by about a d o l l a r t o around $16 d o l l a r s a b a r r e l i n t h e second and t h i r d q u a r t e r s o f t h i s year as t h e i n i t i a l market r e a c t i o n t o OPEC's l a t e s t attempt t o r e s t r i c t supply and r a i s e p r i c e s d i s s i p a t e s and seasonal t i g h t n e s s i n t h e o i l market eases.
W believe e
t h a t OPEC w i l l n o t be f u l l y successful i n pushing t h e average p r i c e o f crude above $18 do1 l a r s l a r g e l y because we a n t i c i p a t e t h a t presumptive
OPEC quotas w i l l be exceeded somewhat.
However. we are assuming t h a t ,
b y 1988, r i s i n g consumption i n i n d u s t r i a l c o u n t r i e s coupled w i t h no growth i n production o u t s i d e o f OPEC w i l l lead t o a gradual r i s e i n the
import p r i c e , reaching $17.50 per b a r r e l b y t h e end of t h e
p r o j e c t i o n period.
As a consequence o f these influences, t h e r a t e of consumer
p r i c e i n f l a t i o n i n i n d u s t r i a l countries--shown Chart 7--is expected t o p i c k up i n 1987.
i n t h e upper panel o f
However, because o f t h e
d o l l a r ' s depreciation, t h e r a t e o f i n f l a t i o n w i l l be s u b s t a n t i a l l y lower i n t h e major f o r e i g n i n d u s t r i a l c o u n t r i e s
on average than i n t h e U n i t e d
Thus, t h e d o l l a r ' s
S t a t e s , r e v e r s i n g t h e p a t t e r n o f recent years.
p r o j e c t e d d e p r e c i a t i o n i n r e a l , o r price-adjusted, terms against t h e currencies o f these c o u n t r i e s w i l l be l e s s than i t s d e p r e c i a t i o n i n nominal terms. Aside from p r o j e c t e d trends i n competitiveness, a k e y determinant of t h e s t a f f ' s outlook f o r t h e U.S. external position is
t h e prospective s t r e n g t h o f economic a c t i v i t y i n t h e f o r e i g n i n d u s t r i a l countries, e s p e c i a l l y i n Japan and Europe. The r e d bars i n t h e middle
panel show t h a t domestic demand i s estimated t o have accelerated i n these c o u n t r i e s
in 1986, b u t r e a l GNP decelerated.
represents i n l a r g e p a r t reduced n e t exports t o OPEC, Eastern Europe and t h e newly i n d u s t r i a l i z e d c o u n t r i e s o f Asia. During t h e f o r e c a s t period, we are p r o j e c t i n g a slowing o f domestic demand i n Japan and Europe, on average, and e s s e n t i a l l y no change i n t h e growth r a t e o f GNP from t h a t estimated f o r 1986. This
p r o j e c t i o n r e l i e s i n p a r t OR a pickup i n investment demands s t i m u l a t e d b y lower i n t e r e s t r a t e s and, i n a few countries, b y e f f o r t s t o
-4r e o r i e n t t h e i r economies.
It assumes some f u r t h e r e a s i n g o f monetary
p o l i c i e s and i n t e r e s t r a t e s , a t l e a s t i n Japan and Germany, as t h e i r currencies continue t o appreciate against the dollar, but it also assumes a c o n t i n u a t i o n o f t i g h t f i s c a l p o l i c i e s - - e x c e p t i n t h e United
Kingdom where f i s c a l p o l i c y has been somewhat e a s i e r i n advance o f t h e election. The b o t t o m p a n e l p r e s e n t s a comparison of t h e growth r a t e o f
GNP i n t h e U n i t e d S t a t e s w i t h t h a t i n - f o r e i g n c o u n t r i e s - ­ all
i n d u s t r i a l i z e d and d e v e l o p i n g combined. Over t h e n e x t two years,
growth abroad i s expected t o be no more r a p i d t h a n t h a t i n t h e U n i t e d States, which b y i t s e l f c o n t r i b u t e s t o a widening o f o u r t r a d e Moreover, a comparison w i t h t h e m i d d l e p a n e l shows t h e pace
of economic a c t i v i t y i n Japan and Europe i s expected t o l a g b e h i n d t h a t i n other f o r e i g n countries. A g a i n s t t h i s background of s l u g g i s h growth abroad, most o f t h e p r o j e c t e d expansion i n t h e volume o f U.S. n o n a g r i c u l t u r a l exports, shown
by t h e r e d l i n e i n t h e t o p panel of t h e n e x t c h a r t , w i l l b e p r o p e l l e d b y t h e improved p r i c e c o m p e t i t i v e n e s s o f U.S. four q u a r t e r s of 1986 t h e volume of U.S. products. Indeed, over t h e
i n c r e a s e d b y an e s t i m a t e d 13 percent; t h e increases were widespread across commodity c a t e g o r i e s , as has been a t t e s t e d t o b y t h e i n f o r m a t i v e s u r v e y conducted b y t h e Reserve Banks, and t h e i n c r e a s e i n e x p o r t s t o Western Europe was p a r t i c u l a r l y pronounced. W are p r o j e c t i n g increases e
i n t h e volume o f n o n a g r i c u l t u r a l e x p o r t s i n t h e same range--around 15 p e r c e n t p e r y e a r - - d u r i n g 1987 and 1988. W a l s o expect t h e average e
p r i c e o f t h e s e e x p o r t s t o p i c k up somewhat under t h e i n f l u e n c e o f r i s i n g
-5p r i c e s here and abroad and t h e d o l l a r ' s depreciation, f u r t h e r b o o s t i n g t h e increase i n t h e i r value. I n c o n t r a s t , as i s shown i n t h e m i d d l e panel, we a r e p r o j e c t i n g l i t t l e f u r t h e r expansion i n t h e volume of our a g r i c u l t u r a l exports f o l l o w i n g t h e bounceback i n l a t e 1986 produced by lower U.S. support p r i c e s . Although a few commodities such as soybeans and c o t t o n
may b e n e f i t f r o m s p e c i a l s i t u a t i o n s , and p r i c e s o f a g r i c u l t u r a l exports a r e expected t o p i c k up a b i t on average i n 1988, t h e general worldwide excess supply o f a g r i c u l t u r a l commodities coupled w i t h t h e l e v e l o f our support p r i c e s should l i m i t t h e scope t o expand t h e volume o f our a g r i c u l t u r a l exports. With a d e c l i n i n g t r e n d i n domestic p r o d u c t i o n o f crude o i l and a r i s i n g t r e n d o f consumption, t h e volume o f U.S.
o i l imports, shown by
t h e r e d l i n e i n t h e bottom panel, i s p r o j e c t e d t o increase a t about a
4 percent annual r a t e a f t e r t h e f i r s t q u a r t e r o f t h i s year.
It1 t h e
c u r r e n t quarter, however, we a r e a n t i c i p a t i n g a f u r t h e r d e c l i n e f o l l o w i n g t h e surge l a s t summer. o i l p r i c e s , t h e value o f U.S. Meanwhile, given our assumption about
o i l imports should r i s e s i g n i f i c a n t l y over
t h e f o r e c a s t period--by about $13 b i l l i o n b y t h e f o u r t h q u a r t e r o f 1 9 8 8 - - s i g n i f i c a n t l y damping t h e improvement i n our t r a d e balance. Turning t o t h e outlook f o r n o n - o i l imports, t h e t o p panel o f t h e Chart 9 shows t h a t t h e p r i c e s of these imports have on average advanced a t an i n c r e a s i n g l y r a p i d pace over t h e p a s t 18 months. However, as was r e p o r t e d i n t h e Reserve Bank survey, increases have been f a r from u n i f o r m across commodity categories. The l a t e s t d a t a from t h e
BLS, which were r e l e a s e d a f t e r t h e f i r s t estimates o f f o u r t h - q u a r t e r GNP
were announced and a r e shown i n parentheses, suggest n o t q u i t e so r a p i d
an increase i n p r i c e s o f c e r t a i n categories o f goods as had been estimated e a r l i e r . With p r o f i t margins abroad more squeezed than they
irere 24 and even 12 months ago, we are p r o j e c t i n g a f u r t h e r a c c e l e r a t i o n i n t h e average p r i c e o f n o n - o i l imports as i s shown i n t h e middle panel. Consequently, as depicted i n t h e bottom panel, w expect t h e e volume o f n o n - o i l imports t o d e c l i n e s l i g h t l y over t h e f o r e c a s t p e r i o d w h i l e t h e value o f these imports continues t o advance a t a r a p i d rate--about 7-1/2 percent per year. The next c h a r t provides a summary o f our f o r e c a s t f o r t h e c u r r e n t account and r e a l n e t exports o f goods and services i n t h e GNP accounts.
( I would note t h a t i n preparing t h e f o r e c a s t we have made t h e
i m p l i c i t assumption t h a t i t s o v e r a l l contour w i l l n o t be a f f e c t e d s i g n i f i c a n t l y b y t h e t r a d e l e g i s l a t i o n now under consideration i n t h e Congress.) Taking other r e l e v a n t f a c t o r s i n t o account, we h o p e f u l l y
p r o j e c t t h a t t h e c u r r e n t account balance--the b l a c k l i n e i n t h e upper p a n e l - - w i l l bottom out i n t h e c u r r e n t quarter; t h i s q u a r t e r ' s d e t e r i o r a t i o n i s more than accounted f o r b y t h e bounceback i n t h e p r i c e
o f imported o i l .
For t h e balance o f t h e f o r e c a s t period, t h e c u r r e n t Meanwhile, t h e improvement i n r e a l
account should improve gradually.
GNP n e t exports o f goods and services--the r e d line--should be more
dramatic because t h a t measure o f our external p o s i t i o n w i l l n o t be a f f e c t e d b y t h e d e t e r i o r a t i o n i n our terms of trade. The t a b l e a t t h e bottom o f t h e c h a r t l a y s out our best p o i n t estimates o f t h e c o n t r i b u t i o n s o f various f a c t o r s t o changes i n r e a l GNP n e t exports. The f i r s t l i n e i n the t a b l e i n d i c a t e s t h e estimated
effects o f the d o l l a r ' s depreciation since the f i r s t quarter o f 1985.
I t combines b o t h d i r e c t p o s i t i v e effects--through
changes i n impacts on
r e l a t i v e prices--and i n d i r e c t negative effects--through economic a c t i v i t y .
The estimated n e t e f f e c t was s i g n i f i c a n t d u r i n g
1986. and i s expected t o peak d u r i n g 1987 and taper off d u r i n g 1988. The second l i n e , on t h e same basis, shows t h e effect o f t h e p r o j e c t e d f u r t h e r r e a l d e p r e c i a t i o n o f t h e d o l l a r . The estimated e f f e c t i s q u i t e small d u r i n g 1987, b u t increases i n 1988. The t h i r d l i n e i n t h e t a b l e shows t h e combined i n f l u e n c e o f o t h e r f a c t o r s ; f o u r negative f a c t o r s can be i d e n t i f i e d . The f i r s t i s
t h e f u r t h e r e f f e c t on t h e l e v e l o f both exports and imports of t h e d o l l a r ' s appreciation
prior - t h e f i r s t q u a r t e r o f 1985; t h i s f a c t o r to
was important i n 1986 and continues t o be important i n 1987. Second i s t h e induced r i s e i n the volume o f o i l imports brought about b y lower o i l prices. T h i r d i s t h e c o n t r i b u t i o n of r e l a t i v e GNP growth here and Last i s the influence
abroad t o t h e widening o f t h e u n d e r l y i n g d e f i c i t .
o f increased i n t e r e s t payments on our net i n t e r n a t i o n a l investment p o s i t i o n , which becomes i n c r e a s i n g l y negative as our c u r r e n t account d e f i c i t s persist. Chart 11 presents a summary o f U.S. transactions. international capital
I would note t h a t these s t a t i s t i c s , which are recorded ex
post, can t e l l one v e r y l i t t l e about motivation, i n c l u d i n g those of p o t e n t i a l Japanese i n v e s t o r s i n U.S. Treasury s e c u r i t i e s . I n 1986, a
d e c l i n e i n p r i v a t e c a p i t a l i n f l o w s - - l i n e 2 - - i s estimated t o have been compensated b y an increase i n o f f i c i a l c a p i t a l i n f l o w s - - l i n e 7--that was
more t h a n accounted f o r by t h e G-10 c o u n t r i e s . expected t o c o n t i n u e i n 1987. W i t h i n t h e c a t e g o r y o f p r i v a t e c a p i t a l flows, n e t i n f l o w s t h r o u g h U.S. banking o f f i c e s - - l i n e 3--declined l a s t year and a r e These t r e n d s a r e
expected t o edge down f u r t h e r t h i s year.
Inflows through n e t f o r e i g n
purchases o f bonds and s t o c k s - - l i n e 4--increased somewhat i n 1986. However, t h e o v e r a l l i n c r e a s e combined a d r o p - o f f i n recorded n e t purchases o f U.S. Treasury s e c u r i t i e s b y p r i v a t e foreigners, continued
l a r g e n e t purchases o f c o r p o r a t e bonds, and a sharp expansion i n n e t purchases o f U.S. c o r p o r a t e stocks. W anticipate that t h i s last e
c a t e g o r y w i l l n o t show as much s t r e n g t h a f t e r t h e f i r s t q u a r t e r o f 1987. F i n a l l y , d i r e c t investment showed a resumption o f n e t o u t f l o w s i n 1986 d e s p i t e p l e n t i f u l anecdotes about i n c r e a s e d f o r e i g n d i r e c t investment i n t h e U n i t e d States. Part o f t h e explanation f o r the increased outflows
l a s t year l i e s w i t h t h e v a l u a t i o n e f f e c t s o f t h e d o l l a r ' s d e p r e c i a t i o n on new investments and r e i n v e s t m e n t o f earnings abroad. The lower
amount o f r c o r d e d i n f l o w s i n p a r t r e f l e c t s t h e absence o f major f o r e i g n takeovers and mergers. M r . P r e l l w i l l now c o n t i n u e o u r o r e s e n t a t i o n .
Michael J . P r e l l FOMC Chart Show February 10, 1987
Domestic Economic and F i n a n c i a l Outlook Chart 12 a d d r e s s e s t h e i m p l i c a t i o n s of t h e projected output and t r a d e developments f o r p r e s s u r e s on domestic r e s o u r c e s . With improved t r a d e perfor­
mapfe, g a i n s i n i n d u s t r i a l production should outpace growth i n GNF’.
r e s u l t , t h e o v e r a l l r a t e of c a p a c i t y u t i l i z a t i o n - - i n
t h e upper l e f t panel-is
p r o j e c t e d t o r i s e t o 81-1/2 percent by l a t e next y e a r , a shade above t h e ‘84 recovery high. On t h e l a b o r s i d e , p r e s s u r e s on supply w i l l depend i n p a r t on t h e r a t e of p r o d u c t i v i t y i n c r e a s e . The c y c l i c a l l y a d j u s t e d t r e n d of output per hour f o r by t h e r e d l i n e i n t h e In
t h e nonfarm b u s i n e s s s e c t o r a s a whole--represented r i g h t panel--appears
t o have improved i n t h i s decade, b u t not very much.
our p r o j e c t i o n , a c t u a l p r o d u c t i v i t y growth p a r a l l e l s t h e estimated t r e n d of j u s t over 1 percent per annum. W expect t h a t manufacturing e f f i c t e n c y will continue t o show t h e most e r a p i d improvement, so t h a t t h e demand f o r a d d i t i o n a l f a c t o r y workers w i l l be limited--as i n d i c a t e d by t h e r e d l i n e a t t h e lower l e f t ; however, t h e growth
of jobs in t h e service-producing s e c t o r is expected t o be s t r o n g enough t o pro­ duce a t o t a l p a y r o l l i n c r e a s e only moderately below t h e pace t o d a t e i n t h e expansion. With a c o n t i n u a t i o n of t h e r a p i d r i s e i n l a b o r f o r c e p a r t i c i p a t i o n a t t h e right--the expected growth i n employment w i l l pro­ However, i t i s our
by a d u l t women--shown
duce j u s t a mild downdrift i n t h e unemployment r a t e .
disi assessment t h a t t h e unemployment r a t e is moving i n t o t h e range where t h e ­n ­ f l a t i o n a r y p r e s s u r e s on wages, i n t h e aggregate, w i l l abate. The performance of wages l a s t year c l e a r l y was f a v o r a b l e . The upper p a n e l s
of Chart 13 p r e s e n t d a t a on t o t a l hourly Compensation from t h e BLS employment Cost indexes.
As you can s e e , t h e d e c e l e r a t i o n of compensation extended beyond
t h e goods-producing and unionized segments of t h e workforce.
Although business
is expected t o p i c k up i n some hard-pressed i n d u s t r i e s , e f f o r t s t o c o n t a i n wage
and o t h e r l a b o r c o s t s a r e n o t l i k e l y t o disappear overnight. One might a l s o
c o n j e c t u r e t h a t t h e "wage norms" i n t h e minds of l a b o r and management have g e n e r a l l y been lowered, providing some i n e r t i a l f o r c e toward moderate pay increases. Nonetheless, as t h e middle panel i n d i c a t e s , we t h i n k t h a t somewhat g r e a t e r l a b o r market t a u t n e s s , combined w i t h f a s t e r r i s i n g p r i c e s , w i l l l e a d t o some a c c e l e r a t i o n i n pay rates i n t h e period ahead. -the T h i s means t h a t u n i t l a b o r costs
b l a c k l i n e - - w i l l pick up s l i g h t l y , t o about a 3 percent rate of i n c r e a s e
i n 1988. The a c c e l e r a t i o n of p r i c e s i s expected t o be more pronounced, a s t h e economy i s h i t by higher o i l and n o n o i l import p r i c e s .
As i n d i c a t e d i n t h e
bottom p a n e l , p e r s o n a l consumption expenditure p r i c e s a r e p r o j e c t e d t o rise f a s t e r than GNP p r i c e s . The d i s p a r i t y i n i n f l a t i o n r a t e s i s accounted f o r by
t h e g r e a t e r importance of energy i n consumer o u t l a y s and by t h e f a c t t h a t import p r i c e s a f f e c t consumption p r i c e s more d i r e c t l y t h a n they do t h e " p r i c e " of domestic value-added,
or G N P .
Although t h e sharper i n c r e a s e i n consumer
p r i c e s w i l l t e n d t o push up wages through formal and informal COLAS, r e a l wages a r e l i k e l y t o be eroded i n t h e s h o r t run. That phenomenon i s v i s i b l e i n t h e t o p panel of t h e next c h a r t , where
real d i s p o s a b l e income growth--the
red bars--is
p r o j e c t e d t o slow i n 1987 and T h i s r e t a r d a t i o n of income growth
1988. d e s p i t e t h e c u t i n p e r s o n a l t a x r a t e s .
a s s o c i a t e d w i t h r i s i n g p r i c e s on t r a d a b l e goods i s one of t h e channels by which r e s o u r c e s are s h i f t e d away from domestic spending and toward improvement of
our e x t e r n a l p o s i t i o n .
The slowing i n r e a l income growth, along with
t h e p o s s i b i l i t y t h a t a four-year binge of d u r a b l e s purchases h a s l e f t many consumers f a i r l y w e l l stocked up, i s expected t o r e s u l t i n a c o n s i d e r a b l e slowing in t h e growth of consumer spending. The gap between t h e 1987 b a r s may
i n a s e n s e o v e r s t a t e t h e case; as J i m Kichline noted, i n c e n t i v e s and t a x e f f e c t s advanced some a u t o purchases i n t o the l a t t e r h a l f of l a s t year. The
b a s i c t h r u s t of our p r o j e c t i o n is simply t h a t o u t l a y s a r e u n l i k e l y t o continue outpacing income gains.
A s e a r c h f o r t h e downside r i s k s in t h i s p r o j e c t i o n l e a d s one f a i r l y
q u i c k l y t o t h e r e c o r d consumer debt burdens and t o i n d i c a t i o n s , such a s t h e delinquency rates shown a t t h e middle l e f t , t h a t some households a l r e a d y are having t r o u b l e s e r v i c i n g t h o s e d e b t s , e s p e c i a l l y in t h e p a r t s of t h e country where t h e economy has been s o f t . But, i n our f o r e c a s t , we've a l s o given weight
t o t h e p o s i t i v e s i g n s r e g a r d i n g consumer sentiment--such
as t h e survey r e s p o n s e s
a t t h e r i g h t , where any r e a d i n g over 100 i n d i c a t e s t h a t more households p e r c e i v e
t h e i r f i n a n c e s t o have improved than t o have d e t e r i o r a t e d over t h e past year. While t h e p r o p e n s i t y t o consume o u t of i n c r e a s e s i n a s s e t v a l u e s may n o t be very h i g h , t h e tremendous rise in n e t worth--if sustained--ought,
of t h e h i s t o r i c a l p a t t e r n s suggested by t h e bottom p a n e l , t o h e l p hold p e r s o n a l saving out of c u r r e n t income a t a low percentage. I should note t h a t the s t o c k
market r i s e s i n c e January 1, which is - r e f l e c t e d i n t h e c h a r t , a l r e a d y has not surpassed t h a t f o r a l l of 1986. W a l s o are modestly hopeful about t h e outlook f o r t h e housing s e c t o r , e our comfortable l e v e l in t h a t forecast: having r i s e n with t h e r e c e i p t of t h e s t r o n g e r December d a t a . T o t a l housing starts, in t h e top p a n e l of Chart 1 5 , are
expected t o equal or exceed t h e fourth-quarter r a t e over t h e p r o j e c t i o n period. P r i o r t o December, s i n g l e - f a m i l y starts and new home s a l e s were t r e n d i n g
downward, even though, as may be seen in t h e m i d d l e - l e f t panel, d e c l i n i n g i n t e r e s t r a t e s were reducing t h e monthly payment burdens a s s o c i a t e d w i t h new home purchases.
A v a r i e t y of f a c t o r s may have been working t o o v e r r i d e the
f i n a n c i a l s t i m u l u s , b u t i t seems l i k e l y t h a t t h e c o n t r a c t i o n i n t h e oil p a t c h economy-where housing s t a r t s have dropped sharply-was significant. However,
t h a t r e g i o n a l d e c l i n e may now have l a r g e l y r u n i t s c o u r s e , and w i t h mortgage r a t e s having f a l l e n s t i l l f u r t h e r r e c e n t l y , we b e l i e v e t h a t single-family b u i l d i n g should do r e a s o n a b l y w e l l .
On t h e m u l t i f a m i l y s i d e , t h e p r o j e c t i o n is
f o r c o n s t r u c t i o n a c t i v i t y t o remain below t h e pace of t h e p a s t couple of y e a r s , owing both t o t h e b i g overhang of vacant r e n t a l u n i t s , e s p e c i a l l y in t h e South -shown a t t h e right-and t o adverse changes i n t a x laws.
P u l l i n g t o g e t h e r t h e income and expenditure p r o j e c t i o n s f o r t h e household s e c t o r , along w i t h a n allowance f o r l i k e l y demands f o r f i n a a c i a l assets, we are l e f t w i t h a s i z a b l e gap t o be f i l l e d by borrowing.
As you c a n s e e in
t h e bottom panel, our f o r e c a s t p o i n t s t o a continued l a r g e n e t flow of mortgage p l u s consumer borrowing i n 1967 and 1988. s e c t n r deht i n percentage terms--at The growth of o u t s t a n d i n g household only s l i g h t l y , and con­
t h e right-slows
t i n u e s t o exceed income growth by a wide margin.
P a r t l y because of t h e reduced
d e d u c t i b i l i t y of consumer l o a n i n t e r e s t , w e a r e expecting t h a t t h e r e w i l l be a n o t i c e a b l e s h i f t toward mortgage borrowing.
It is d i f f i c u l t a t c h i s s t a g e t o
a s s e s s t h e p o t e n t i a l importance of home e q u i t y l i n e s ; we have made what we t h i n k is a c o n s e r v a t i v e assumption, but t h a t allowance s t i l l i s enough t o c u t consumer l o a n growth s u b s t a n t i a l l y . Turning t o t h e b u s i n e s s s e c t o r , i n t h e next c h a r t , w e expect t o s e e a c o n t i n u a t i o n of t h e c r o s s c u r r e n t s in c a p i t a l spending t h a t have c h a r a c t e r i z e d t h e p a s t year--namely, weak s t r u c t u r e s o u t l a y s and moderately expanding equipment
However, one big negative in the investment picture should be behind
us now, unless o i l prices collapse once again. As you can see at the right, the direct effect alone of declining oil drilling was nearly enough to account for the drop in business fixed investment last year.
In the period since oil prices
reached their lows last summer, drilling activity seems to have bottomed out, as indicated by the rig count in the middle left panel. Nonetheless, we do not expect to see total structures outlays rising soon, given the high vacancy rates
in office buildings--shown at the right--hotels, and other commercial structures.
Of course, tax reform i s a negative for this sector, too-and
that the aggressive lendjng practices that have fueled this market are becoming less common.
In the case of equipment spending, the elimination of the invest­
ment tax credit will have an adverse effect; however, we believe the continuing needs for replacement and modernization will, along with improved sales pros­ pects in manufacturing, yield at least moderate gains in real outlays.
A rising trend of factory shipments also would encourage stronger inven­
tory investment.
During the past year, manufacturers have gradually run down
their stocks, contributing to the net decline in the inventory-sales ratio in the bottm panel. We anticipate that inventory management will remain cautious
for a while, and that the stock-to-sales ratio will continue
Nevertheless, as may be seen at the right, this still would permit a bit greater accumulation of nonfarm inventories than we saw in 1986.
As in the household sector, balance sheet considerations are something of
a questionmark on the business side. As may heen seen in the top panel of the Chart 17, although internal funds generatlon will be damped by higher corporate
taxes, our investment projection implies only a moderate financing gap in the
period ahead. Nonetheless, some analysts have expressed concern that balance
-6 sheet constraints will put a l i d on capital spending. A number of companies have indeed put themselves in something of a financial straitjacket, by sharply
increasing their indebtedness in connection with mergers, buyouts, or share
The effects on leverage at an aggregate level are visible in the
"book" debt-equity ratio shown in the middle left panel. But, as the black
line indicates, this financial restructuring has, for the time being, been
rewarded by the stock market, so that when the corporate debt-equity ratio is
gauged using market valuations of bonds and stocks, the apparent increase in
leveraging largely disappears. In addition, the decline in interest rates has
helped to hold down debt servicing expenses, and aggregate interest coverage
hasn't deteriorated.
Just how much is lost Cn looking at the corporate sector
as a whole is hard to say; it seems clear that a good many companies would
find themselves in difficulty if there were to be a recession or a major upswing
in interest rates, but it is our judgment that balance sheet considerations
are not at present a serious impediment to overall capital spending.
Looking at the prospective pattern of corporate financial activity, we must acknowledge that forecasting the volume of mergers and other restructurings has proven to be about as treacherous as predicting M1 velocity. Our ansumption
is that the tax law changes will help to slow the retirement of equity shares. At the same time, we expect that gross issuance of new stock will remain substan tial.
So, as you can see in the bottom panel,
net equity tssuance is projected
The enlarged financing
to be less negattve in 1987 and '88 than it has been.
gap, however, will tend to sustain borrowing at a relatively high level.
sent an appreciahle deterioration in the bond market, in terms of either rates
or access on the part of less-than-prime companies, the bulk of the borrowing
is likely to remain longer term.
-7I n a s e n s e , f i n a n c i a l c o n s t r a i n t s on spending seem t o loom l a r g e s t i n t h e c a s e of t h e government s e c t o r . The t o p p a n e l of t h e next c h a r t a d d r e s s e s A s you can s e e ,
t h e f e d e r a l spending p i c t u r e i n terms of GNP r e a l purchases.
s l i c i n g away the n o i s e of CCC a c t i v i t i e s , which simply s h i f t farm s t o c k s i n and out of p r i v a t e hands, f e d e r a l spending is expected e s s e n t i a l l y t o f l a t t e n out a f t e r a p e r i o d of r a p i d expansion paced by s o a r i n g defense o u t l a y s .
For s t a t e and l o c a l governments, we are p r o j e c t i n g s m a l l e r i n c r e a s e s i n real purchases.
The more s u b s t a n t i a l g a i n s i n 1985 and '86 r e f l e c t e d in p a r t a The momentum of
b i g jump i n c o n s t r u c t i o n a c t i v i t y , portrayed a t t h e r i g h t .
major i n f r a s t r u c t u r e programs should hold p u b l i c c o n s t r u c t i o n a t a higher l e v e l f o r a while, b u t t h e p o t e n t i a l f o r f u r t h e r expansion seems l i m l t e d in l i g h t of t h e f i n a n c i a l s t r e s s e s f e l t i n some a r e a s .
As i n d i c a t e d a t t h e lower l e f t , t h e
s e c t o r ' s budget s u r p l u s was buoyed l a s t year by one-time flows a s s o c i a t e d w i t h o f f s h o r e l e a s e proceeds and o t h e r s p e c i a l f a c t o r s . Now, s t a t e s and l o c a l i t i e s
are faced with the l o s s of f e d e r a l revenue s h a r i n g and many a r e s t r u g g l i n g with
t h e n e g a t i v e e f f e c t s of slumping economies on t h e i r t a x bases. Although t a x
reform w i l l provide a w i n d f a l l f o r many s t a t e s , t h e s e c t o r ' s o v e r a l l budget p o s i t i o n i s l i k e l y t o d e t e r i o r a t e i n 1987. This should n o t p r e v e n t a r e d u c t i o n
i n n e t borrowing by s t a t e and l o c a l governments, however.
A l o t of money was
r a i s e d during t h e p a s t two y e a r s t o b e a t t a x reform r e s t r i c t i o n s and is now a v a i l a b l e t o fund p r o j e c t s . That s a i d , t h e r e s t i l l could be a n upside s u r p r i s e
i n state and l o c a l borrowing if u n i t s become p a r t i c u l a r l y anxious t o undertake advance r e f u n d i n g s or if t h e t a x a b l e muni market becomes a major v e h i c l e f o r arbitrage. Barring such developments, t h e combination of reduced f e d e r a l and s t a t e and l o c a l borrowing should r e s u l t i n a r e d u c t i o n i n aggregate borrowing t h i s y e a r , as shown i n t h e next c h a r t .
T r a n s l a t e d i n t o percentage growth r a t e s , as i n t h e bottom p a n e l , t h e domestic debt a g g r e g a t e i s p r o j e c t e d to d e c e l e r a t e considerably from t h e pace of t h e p a s t f e w years. But, while t h e gap between debt growth and G growth "
i s m p e c t e d t o narrow, i t remains d e c i d e d l y p o s i t i v e .
T h i s i s j u s t one more
reminder t h a t t h e economic environment we have f o r e c a s t i s u n l i k e l y t o r i d t h e system of t h e f i n a n c i a l v u l n e r a b i l i t i e s t h a t have been a source of concern f o r some time now.
Mr. Kichline w i l l now conclude our p r e s e n t a t i o n .
Chart 20 provides a summary of 1987 forecasts of Board members and presidents along with those of the staff and the Administration. The forecast ranges for Board
members and presidents, taken together, encompass the Administration's projection for each of the variables. In
general, however, the Administration tends to be on the high
side for nominal and real GNP as well as for the GNP
deflator. There is little difference on the unemployment
rate for all the forecasts.
The table at the bottom provides the forecasts
presented to the Congress last July. The central tendencies
of the forecast indicate that current expectations for both
real GNP and the deflator have been reduced somewhat.
During the presentation we've attempted to display
the major features of the staff's outlook and have pointed
to a number of areas of vulnerability.
It's a forecast that
we believe to be most likely given the conditioning
assumptions and one that for 1987 does not have risks
particularly weighted to one or the other side in our
thinking. The forecast is also one that contains some
reduction, even though limited, in key imbalances in the
economy--especially the trade and federal budget deficits.
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