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Views on the Economy, Monetary Policy

Top of the Ninth

June 1, 1993


Views on the Economy, Monetary Policy

Following is a summary of Gary Stern's March 10, 1993, testimony before the Senate Committee on Banking, Housing and Urban Affairs. Stern, along with the other 11 Federal Reserve bank presidents, was called to testify on the state of the district economy and to share his views on monetary policy.

Mr. Chairman and members of the Committee, I appreciate this opportunity to discuss with you economic conditions in the Ninth Federal Reserve District and my views on monetary policy. My task is somewhat easier today than it would have been eight years ago, right after I first took office. Over this period economic conditions generally have improved in the Ninth District, and over this period I have had the opportunity to refine my views on the role and conduct of monetary policy. Let me briefly address these two topics in turn.

The Ninth District economy is doing well relative to the national economy today, in large part because it did not participate as fully as some of the regions of the nation in the expansion and excesses of the middle and late 1980s. While the rest of the nation was affected by unsustainable expansions and subsequent sharp contractions in some sectors the Ninth District was more steady-as-you-go. Moreover, inflation appears to have diminished in the district in recent years.

The Ninth District has a relatively small population, but it is large geographically and contains a diverse industrial base. The Ninth District includes the states of Montana, North Dakota, South Dakota, and Minnesota, as well as western Wisconsin and the Upper Peninsula of Michigan. Important in the district are the natural resource industries of agriculture, forest products and mining; diverse manufacturing industries including modern computer, electronic and medical technologies; and tourism.

In the middle and late 1980s the district economy was a bit weaker than the national economy. The district did not benefit as much as others from the defense build-up, the commercial construction spree, or the real estate price run-up. Consequently, though, when these areas turned down, the district economy was affected relatively less than the national economy.

In addition, the district has been fortunate to have some growth industries within its borders. The district economy has been supported by growth in exports, medical instrument manufacturing, residential construction, medical services and tourism. And, notably, agriculture has for the most part recovered appreciably from the serious problems of the mid-1980s.

However, I do not want to give the impression that all is well in the Ninth District. Not all industries and not all regions are prospering. In particular, some natural resource industries, commercial construction, computer manufacturing and small-town retail stores all have been slumping to some degree. Nevertheless, I think it is fair to say that as a whole the district economy has improved.

The fortunes of the district's banks largely have reflected the ups and downs of the district's economy. In 1986 the district's banking system was far from healthy. The lagging effects of the 1981-82 recession, difficulties in the agricultural sector and problems with loans to less developed countries had combined to weaken banks' financial condition. But since then, banking conditions have improved. Asset quality, earnings and capital all have improved. In the first three quarters of 1992 only 2 percent of the district's banks reported losses, down from 20 percent in 1986.

Much of the information I get on the district economy comes first-hand from District Dialogues with community and business leaders and from meetings with the bank's directors and advisory council on small business, agriculture and labor. Our involvement in district economic affairs has served both the community and Federal Reserve policymaking well, I believe.

The state of, and prospects for, the regional economy are important elements in my preparation for an approaching Federal Open Market Committee meeting. But, of course, regional considerations must be balanced and integrated with information about the national and international economy, for ultimately the effects of monetary policy transcend regional boundaries. Thus, a wide range of factors, combining regional economic and financial information with additional perspectives, helps to shape my view of the appropriate course of policy.

In the broadest sense, and taking a long-run perspective, the object of monetary policy is, it seems to me, to attain the highest possible living standards for our citizens over time. In order to give this goal operational meaning, the Federal Reserve in my view should seek to achieve over time maximum sustainable growth of real output.

My reading of the accumulated evidence on economic performance both here and abroad is that in the long run the most significant contribution monetary policy can make to achieving maximum sustainable growth in real output is to foster price stability. That is, I am convinced that in the long run, price stability goes hand-in-hand with sustained economic prosperity. The two goals are not antithetical and, indeed, price stability is best thought of as a means to the end of sustained prosperity.

In the short run, we in the Federal Reserve may indeed find it appropriate to respond to incoming financial and economic information in order to keep the economy on, or to return it to, its potential growth path. But, it seems to me, our short-run response should in general be cautious because of uncertainty both about the state of the economy and about the effects of policy on the economy. Moreover, we need to avoid the problem of turning long-run policy into a sequence of short-run decisions. If followed, such an approach runs the risk of adopting a strategy that is persistently inflationary or contractionary, depending on conditions prevailing when it is adopted.