mr. meyer gives his views on the conduct of monetary policy in the united states testimony by mr. laurence h. meyer, a member of the board of governors of the us federal reserve system, before the committee on banking and financial services of the us house of representatives in washington dc on 23 / 7 / 97. i am pleased to have this opportunity to meet with you this morning to discuss my views on the conduct of monetary policy. i am well aware that, despite the recent good performance of the economy, some members of this committee have reservations about the conduct of monetary policy, specifically the decision to raise the federal funds rate ¼ percentage point on march 25. i am also aware that there has been interest by some members, particularly congressman frank, in my views, specifically my views about the relevance of the nairu concept to understanding recent economic performance and risks to the outlook. i welcome the chance to discuss these issues with you this morning. achieving price stability in the long run and preventing an increase in inflation in the short run are not ends in themselves. they are a means to the end, important because they are the best way that the federal reserve can contribute to achieving the highest sustainable level of production and the maximum sustainable rate of growth for the american people. this is a key point. while there may be, from time to time, differences about how to reach these common goals - - indeed, it would be amazing if there were not - - there is no disagreement about the goals. the history of business cycles has repeatedly taught us that the greatest risk to an expansion comes from failing to prevent an overheated economy. the best way to insure the durability of this expansion is, therefore, to be vigilant that we do not allow the economy to overheat and produce the inevitable rise in inflation. failure to heed this lesson of history would result not only in higher inflation, but also in cyclical instability and higher unemployment rates. one way of explaining the recent good performance in the economy is that policymakers have created a favorable environment for the private sector and then gotten out of the way, allowing the natural dynamism of our economy to operate to its potential. monetary policy has laid the groundwork of stable, low inflation - - an environment conducive to long - term planning by households and businesses. fiscal policy has helped lower the deficit and thus has increased national saving and reduced its competition for funds with the private sector. trade policy has opened markets and

of income has been rising, why inflation is so well contained, and why stock prices have soared. the only problem is the data. it is true that productivity has increased more rapidly recently. this is not clear - cut evidence of a shift in the productivity trend, however, because productivity normally accelerates when output growth rises, as it has over the last year. there is, however, some support for the view that we are experiencing a speed - up in the trend rate of productivity growth. for example, if we measure productivity from the income side rather than the product side of the national accounts, we do observe a sharper acceleration in productivity. this income - side measure of productivity provides at least a tantalizing hint of an increase in trend productivity growth. this would also be consistent with a considerable number of reports by businesses that they are realizing new efficiencies in production, both through corporate reorganization and through the application of new technology. what was the rationale for the march 25 tightening? the discussion of the rationale for the march 25 policy move to follow is my personal view. during the period from june 1996, when i joined the board, through february 1997, utilization rates had remained in a very narrow range, in the case of the unemployment rate only a shade below my estimate of nairu. recall that the unemployment rate averaged 5. 4 % in 1996. there was some risk that utilization rates were already so high that inflation might increase over time, but this risk was not clear enough, in my judgment, to justify action. i viewed growth as either close to trend already or about to slow to trend, implying that there was negligible risk that utilization rates would rise further. so, before march 25, the federal reserve ’ s posture was one of “ watchful waiting, ” but with an asymmetric directive, based on the judgment that the risks were weighted toward higher inflation. in march, my view was that there was sufficient momentum in growth to justify a forecast that utilization rates would rise materially further, in the absence of a change in policy. the policy action was clearly a preemptive one, not based on inflation pressures evident at the time, but on inflation pressures likely to emerge in the absence of policy action. as the chairman has repeatedly emphasized, lags in the response to monetary policy make it imperative that monetary policy be forward looking and anticipatory, not backward looking and reactive. one of the principles of prudent monetary policy