AGENDA AND PAPERS FOR THE NOVEMBER 29 MEETING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85-01156R000100160009-1
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 22
• Document Creation Date: December 21, 2016
• Document Release Date: August 20, 2008
• Sequence Number: 9
• Publication Date: November 27, 1984
• Content Type: MEMO

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EXECUTIVE SEAETARIAT
ROUTING SLIP
ACTION
INFO
DATE
INITIAL
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DCI
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DDCI
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EXDIR
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D/ICS
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DDI
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DDA
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DDO
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DDS&T
9
Chm/NIC
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GC
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IG
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Compt
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D/Pers
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D/OLL
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D/PAO
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SA/IA
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AO/DCI
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C/IPD/OIS
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STAT
STAT
2 Nov 84
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? -- 'executive Registry
WASHINGTON
[84. 9981
CABINET AFFAIRS STAFFING MEMORANDUM
Date: 11/27/84 Number: 169095CA Due By:
Subject: Cabinet Council on Economic Affairs Planning Meeting -
November 2.9, 1984 - 8:45 A.M. - Roosevelt Room - TOPIC:
Action FYI
ALL CABINET MEMBERS,' ^ ^
Vice President
State
Treasury
Defense
Attorney General ^
Interior ^
Agriculture
Commerce
Labor i~
HHS
HUD
Transportation
Energy
Education
Counsellor
OM B
CCZA
UN
USTR
GSA
EPA
NASA
OPM
VA
SBA
REMARKS:
Executive Secretary for:
CCCT
CCEA
CCFA
CCHR
CCLP
CCMA
CCNRE
There will be a Cabinet Council on Economic Affairs
Planning Meeting on Thursday, November 29, 1984, at
8:45 A.M. in the Roosevelt Room.
The agenda and background papers are attached.
^ Craig L. Fuller
Assistant to the President
for Cabinet Affairs
CEA
CEQ
OSTP
Financial Market
Developments
Baker
Deaver
Darman (For WH Staffing)
Mc Farlane
Svahn
Chapman
^ Don Claret' Tom Gibson ^ Larry Herbolsheim
Associate Director
Office of Cabinet Affairs
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November 27, 1984
MEMORANDUM FOR THE CABINET COUNCILn ON ECONOMIC AFFAIRS
FROM: ROGER B. PORTER
SUBJECT: Agenda and Papers for the November 29 Meeting
The agenda and papers for the November 29 meeting of the
Cabinet Council on Economic Affairs are attached. The meeting
is scheduled for 8:45 a.m. in the Roosevelt Room.
The Council will consider financial market developments
and monetary policy. The Working Group on Financial Market
Developments has prepared three papers for the Council's
consideration.
The first, from Gregory Ballentine, concerns the economy
and the budget. The paper discusses the effect of quarterly
economic results on budget deficit estimates and briefly
addresses the relationship between long-term deficits and
the economy. A copy of his paper is attached.
The second, from William Poole, concerns general
monetary policy. The paper discusses monetary decelerations
and business cycle peaks, the reasons for procyclical money
growth, the costs of interest rate targeting, and recent
Federal Reserve policy. A copy of his paper is attached.
The third, from Beryl Sprinkel, concerns U.S. monetary
policy and its effect on the domestic and international
economies. The paper discusses the potential effect of
current monetary growth on U.S. GNP growth, trade balance,
and interest rates and its effect on economic growth in other
countries, particularly in Europe and lesser developed
countries. In addition, the paper discusses current market
conditions and Federal Reserve.policy. A .copy of his paper
is attached.
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49 - ?
CABINET COUNCIL ON ECONOMIC AFFAIRS
November 29, 1984
8:45 a.m.
Roosevelt Room
1. Financial Market Developments (CM # 111)
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EXECUTIVE OFFICE OF THE PRESIDENT
OFFICE OF MANAGEMENT AND BUDGET
WASHINGTON, D.C. 20503
November 27, 1984
MEMORANDUM FOR THE CABINET COUN - 0 ECONOMIC AFFAIRS
FROM: J. Gregory Ballentine
? SUBJECT: The Economy and the
Quarterly Economic Results and Deficit Estimates
?
As part of the overview of the budget situation,
possible deficit baselines.
These alternatives usually show that:
alternative forecasts are
frequently used to indicate
-- More optimistic forecasts can lower the deficit, but cannot reasonably be
-- More pessimistic forecasts result in a growing current services deficit.
expected to eliminate it.
o In contrast with such alternative five year forecasts, economic news for a given quarter has relatively
.little effect on the deficit.
Quarterly economic numbers are volatile; thus one quarter's good or bad news should not be used to
change a long-term forecast.
Quarterly changes that do not alter the long-term forecast are not large enough to alter estimates of
future deficits significantly.
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0
Numerical'Effects of Quarterly Economic News
.o On December 19, the Q4 GNP flash will be released. Further, at about that time we will have the actual
interest rate and unemployment rate figures for most of Q4/84. Assume, for purposes of this memorandum
only, that those figures are incorporated in the forecast for Q4/84 with no change in the growth rates or
interest rates in the rest of the forecast (1985 - 1990).
o If the flash real-GNP growth is-2% lower in Q4 than what we forecast, receipts will be lowered by about
the following amount:
($, billions)
1985 1986 1987 1988 1989 1990
4.2 4.8 5.2 5.6 6.3 6.8
-- 2% lower real GNP for one quarter means about 0.5% lower GNP for a year. That translates into about
$19.5 billion to $28.8 billion less GNP a year for 1985-1990. At the margin, about 25% of GNP is
taxed.
o If, in addition, the Q4 deflator is 0.5% below the forecast, this reduction in revenues is about 25%
larger.
o The outlay effects of such a reduction in real growth and inflation are slight.
-- A reduction in real growth may raise unemployment, raising U.I. outlays. If the unemployment rate
rises by 0.3% in Q4/84--Q4/85, 0.29% in 1986, and 0.1% in 1987, then outlays rise by $1.2 billion in
? 1985, $1.0 billion in 1986, and $0.5 billion in 1987.
-- The 0.5% reduction in the deflator, if it results in a corresponding reduction in the CPI, lowers
COLA indexed outlays by the following amounts:
($, billions)
1985 1986 1987 1988 1989 1990
-0.2 -0.3 -0.4 -0.4 -0.4
o Notice that an increase in the unemployment rate raises U.I. outlays only in the year the unemployment
rate is increased. A one-quarter reduction in the deflator, however, raises outlays in all future years.
(Assuming the deflator does not increase above forecast in a future quarter.)
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o Recently, more rapid growth than expected has been associated with interest rates above our forecast, and
slower growth with interest rates below the forecast. If Q4/84 interest rates are 0.6% below the
forecasted level (and then return to the forecast in Q1/85), outlays will be reduced as shown below.
(These figures include the debt service cost of the revenue and outlay changes discussed above.)
($, billions)
1985
1986
1987
1988
1989
1990
2.0
5.6
4.6
2.4
1.0
0.3
Long-term Deficits and the Economy
o Until very recently, and in spite of persistent, though small, Federal deficits, the Federal budget has
57-owed a type of "crowding in" of real capital in the economy in almost every year.
o This is because Federal debt held by the public has fallen as ashare of total private wealth.
FEDERAL LIABILITIES TO PRIVATE WORTH
0
21%
Ox
1040 1981 1073 1083
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o Federal debt is part of the total private wealth, but it is a kind of false wealth. Whereas corporate
bonds, stocks, or other private financial instruments are ultimately backed by some real asset, Federal
government bonds are not.
o Consequently, while an individual holding $100,000 in Federal debt has $100,000 in wealth, society has no
corresponding wealth. (Note that there is no link between Federal debt and holdings of real capital by
the Federal government.)
o Thus, for individuals, Federal government bonds are a substitute for other forms of wealth; forms that
are backed by real assets. This substitutability is the essence of the crowding out phenomenon. For a
given amount of private wealth, the more that is accounted for by Federal debt, the less will be our real
capital stock.
As long as Federal debt grows less rapidly than total private wealth, there is a kind of crowding in that
allows domestically owned real capital to grow faster than total wealth (i.e., faster than total saving
causes wealth to grow).
o This phenomenon allowed domestically owned real capital to grow approximately 25% faster than total
wealth over the period 1949 to 1965, almost certainly contributing to the rapid growth in the 1960's.
o In contrast, from 1965 to 1980 domestically owned real capital grew only 3.8% faster than total wealth.
o For the first time since World War II, Federal debt relative to total wealth began a sustained rise in
1981.
o As a result, the growth in domestically owned real capital will lag the growth in private wealth
throughout the 1980's.
0
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?OUNCIL OF ECONOMIC ADVISERS
WASHINGTON, 0. C. 20500
WILLIAM A. NISKANEN
WILLIAM POOLE
November 27, 1984
MEMORANDUM FOR CABINET COUNCIL ON ECO IC AFFAIRS
FROM : William Poole 1d._ ( g'
'a.
SUBJECT: Monetary Policy
Last Friday the Federal Reserve reported that Ml
declined by $1.3 billion in the statement weekending
November 12. The money stock is now slightly below its
level last June. In June, M1 was at the upper side of the
Fed's announced 4 - 8 percent target growth range; now Ml
is only slightly above the lower side of the target range.
The chart below shows what has happened.
M1 VS.' TARGET RANGE
wMldy Awroges - S.o.onoly Adj.
J,34 F M A M J J
We"
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- 2 -
Slow money growth and the obvious signs that at present
the zip has gone out of the economic expansion have led some
analysts--a distinct minority--to predict a recession next
year. This prediction depends at least as much on
forecasting Federal Reserve policy as on forecasting the
economy's course under given policy assumptions.
Nevertheless, almost all business cycle experts believe that
continued zero money growth will make robust GNP growth in
1985 impossible.
Before taking up the question as to why recent money
growth has been so slow, it is worth reviewing the long-term
record to provide a better basis for assessing the risks to
the economy of present monetary policy.
Monetary Decelerations and Business Cycle Peaks
Evidence that sharp money stock decelerations are
systematically associated with business cycle peaks is
presented in the series of charts on the next few pages.
The charts, which repay careful study, show monthly levels
of Ml and M2 from 1907 to 1972 and M1 from 1970 through
October 1984. (Monthly money stock data are not available
prior to 1907). Business cycle peaks and troughs are
indicated by vertical lines. The time trends in the charts
show the "established" rate of money growth during the
expansion phase of each business cycle; each of these.
established trends is extended forward into the contraction
phase of the cycle.1
A careful study of these charts suggests the following
generalization: at the business cycle peak, give or take a
few months, the money stock is always observed to have
fallen below its established growth trend by 3 to 4
percent. The regularity is striking. Over the whole
history of the monthly money stock series there has never
been a recession when money growth is rising.
'The trends were determined using the same methodology for
all expansions: the "established" trend is the highest
24-month growth trend, estimated through a least-squares
regression, reached during an expansion. The charts for the
period from 1907 to 1972 have been photocopied from a paper
of mine published in The Journal of Finance in 1975. The
charts showing Ml from 19970 to present have been drawn for
this memorandum with the established trends determined as in
my 1975 paper but using the present official definition of
Ml, which differs somewhat from the definition used in
1975. The World War I and II cycle peaks have been excluded
for technical reasons.
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231-
22 21
20
19
1908 1909 1910 1911 1912 1913 1914
P T P
FIGURE I
Money Stock 1908-1972
elaidna
of dollars
1915 1916 1917
8.525%
trend
16.076%
8.485%
trend
trend
^^
^Y^, M.2
sit
^
7.972%
trend
14.390%
^.
trend
6.231%
trend
M?1
1919 1920 1921 1922 1923 1924 1925 1926 1927
9.982%
trend.
T P T j
FIG. 1 (continued)
6.925%
trend
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at ooIiars _-p -2- T P
25
2?
23
1926
1929 1930 1931
6
FIG. 1 (Continued)
oIu,oes
o1, do liars
160
170
160
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100
95
90
IS
60
75
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65
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Flo. I (Continued)
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2?o
230
220:
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0
l as
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-
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50
M?2
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40-
.. .
4.854%
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30
20
10
M?1
1948
1949
1950 1951 1952 19
53 1954 1955 1956 19
57
:
0
1
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8
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21
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1
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811.01$
0 jOll?r? T P T
360
340
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290
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IS
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trend
M-2 a++,a^
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1-11
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,l
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9,
trend
3.687%
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.......
1958
T
1959 1960
P
1961 1962 1963 1964 1965 1966 1967
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Billions
of dollars
640
600
560
520
480
400
380
360
340
320
300
280
260
240
220
200
140
120
100
8.884%
trend .
0110- X X Xx x Xx
XXX X
x
x
x
M?2 XXxx
XXx
XXxxx
XX
7.124%
trend
1968 1969 1970
P T
FIG. 1 (Continued)
1971
1972
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4P 4P
The 1973-75 recession experience is quite typical of
the historical regularity. The downturn in Ml growth
preceding the November 1973 cycle peak is clearly evident in
the chart as is the slower money growth during the
subsequent contraction. However, the evidence for the case
of the January 1980 cyclical peak is less clear. The money
stock had not dropped significantly below its established
trend at the time of this cycle peak. It seems likely that
the unexpected imposition of credit controls in March 1980
brought about a recession sooner than would have developed
naturally; after the fact, the NBER chose January as the
cycle peak month. In any event, money growth declined
sharply after the cycle peak as the recession developed;
needless to say, declining money growth as the recession
took'hold was hardly a constructive development.
A problem arises in interpreting the role of monetary
policy in the 1981-82 recession. If that recession is taken
as an episode separate from the previous cycle, then Ml
never fell much below the established 7.3 percent trend
growth shown in the chart. On the other hand, if the
previous trend line is extrapolated out to the cyclical peak
in July 1981, as shown by the dashed trend, then the decline
An the money stock below its established trend once again
seems to precede the peak.
Why Money Growth is Procyclical
The proximate explanation of procyclical money growth
is that the.money creation mechanism under the Federal
Reserve (and before the establishment of the Federal Reserve
as well) tends to produce rising money growth when interest
rates are rising and falling money growth when interest
rates are falling. This relationship is the normal everyday
one; it dominates the'outcome unless the Federal
Reserve takes vigorous action to overcome the normal
pattern.
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The Federal Reserve's monetary policy procedure can be
described with the aid of the simple diagram below.
The short-term interest rate is on the vertical axis and the
money stock on-the horizontal axis. Since the diagram is
meant to describe short-run nominal money stock
determination, the general price level is taken as
predetermined or at best only slowly adjusting.
The downward sloping money demand curve shows the
quantity of money balances the public desires to hold at a
given interest rate. At a lower interest rate the
opportunity cost of holding money is lower in terms of the
foregone money market yield, and so the public desires to
hold larger money balances. As GNP grows the transaction
demand for money grows and so the money demand curve shifts
rightward. Likewise, as-GNP falls during recessions, the
demand curve shifts leftward because the public wants to
hold less money.
The Fed's money supply curve is also shown in the
diagram. The supply curve is drawn as nearly horizontal
because week by week the Fed is ordinarily willing to supply
vastly,, different quantities of money at only slightly
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different interest rates. Or to-put it differently, through
conscious design the Fed implements monetary policy in the
short run by targeting the federal funds rate and other
short-term interest rates in a relatively narrow range. The
Fed does not literally peg interest rates but cushions
pressures for rates to move. The Fed cushions rate pressures
by adding or draining bank reserves from the economy 'so that
the stock of money changes more or less dollar for dollar as
the public's demand for money changes at the targeted'
interest rate.' By targeting interest rates, the Fed gives
up control over the money stock.
The Cost of Interest Rate Targeting
By targeting interest rates, the Fed can temporarily
smooth rates against various disturbances. If;these
disturbances are rapidly self reversing, then Fed interest
rate smoothing would have little cost and perhaps
significant benefit. However, with interest rate targeting
the Fed creates significant risk for the economy because
some interest rate changes serve the valuable function of
helping to stabilize output, employment and the price
level. Unfortunately, it seems impossible to smooth
temporary interest rate disturbances while permitting
fundamental rate adjustments because neither the Fed nor
anyone else can contemporaneously sort out interest rate
changes that are temporary and self-reversing from those
that are needed to stabilize the economy.
The two most important persistent and destabilizing.
disturbances to the economy involve, on the one hand,
adjustments upward or downward in inflation and anticipated
inflation and, on the other hand, weaknesses in aggregate
demand that can cause a slide into recession. An example of
the first risk is the late 1970s situation: when inflation
got out of hand in 1978-79, the Fed finally recognized that
it had to let interest rates rise substantially to bring
money growth and inflation under control. An example of the
second risk is staring us in the face today.
Real GNP growth has declined recently. A decline in
interest rates as business activity levels off would
automatically raise incentives for spending on investment
and consumer durables and thereby help to stabilize the
economy. Perhaps all that is necessary to keep the present
noninflationary recovery going is a temporary drop in
rates. By interest rate smoothing, the Fed is resisting the
downward pressures on rates as the economy weakens. If
rates are kept too high, temporarily reduced real growth in
the third quarter could turn into the cumulative weakness
that characterizes recessions.
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12 _
Recent Federal Reserve Policy
There is considerable evidence that the Fed is
responsible for the recent flat Ml growth through its
standard policy of attempting to smooth interest rates.After
moving fairly aggressively in the spring and early summer to
constrain money growth, the Fed seems thereafter, until last
week, to have pursued its standard passive policy of
cushioning interest rate changes. At the end of the summer
the market appeared to be bringing the T-bill rate down
ahead of the Fed-controlled federal funds rate. The
evidence that the market is leading the Fed was particularly
strong in early November as the market pulled the T-bill
rate down while the Fed permitted the funds rate to rise
If the Fed, by draining bank reserves, were preventing
the funds rate from'falling as fast and far as the market
wants, the evidence should be in the reserve numbers. It
is. Last June total bank reserves averaged $38.3 billion,
compared to 38.1 in September. Moreover, total reserves fell
further in October and early November, to $37.6 billion in
the statement period ending November 7. The Fed is simply
not providing the reserves growth necessary to support a
growing money stock.
Early this year I argued that money growth in the upper
half of the Fed's target range.of 4 - 8 percent was
appropriate. In June Ml was only slightly below the 8
percent track. Given the present developing slowdown in the
economy it seems clear that we would have been better off if
the money stock had remained in the upper half of the target
range.
The established trend rate of money growth so far
during this expansion, at 10.4 percent, is much too high to
be an appropriate target for the future. From the abnormal
behavior of velocity in 1982-83, and other information, part
of that 10.4 percent established trend should be discounted,
but there is no way,to be sure how much. I had arrived at
my 6 - 8 percent Ml growth recommendation from discounting
3 - 4 percentage points of the money growth from mid 1982 to
mid 1983, and then balancing the risk of rekindling
inflation against the risk that an excessively sharp
deceleration of money growth might lead to recession.
My intuition about these matters should be of less
interest than the fact that no one--monetarist, Keynesian,
or whatever--would last June have recommended essentially
zero money growth for five months as the economy weakened.
As has happened so often in the past, week-by-week concern
over interest rates has led to an unplanned, unwanted, and
undesirable evolution of the money stock.
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Where do we go from here? First, I doubt that near
zero money growth has continued long enough to seal in a
recession. However, the odds on a recession are increasing
substantially with every passing month of very low money
growth. A quick resumption of moderate money growth is
essential. I believe that a 5 - 7 percent M1 growth target
range is appropriate.
Second, the apparent turn to an easier monetary policy
with the cut in the discount rate last week provides
absolutely no assurance whatsoever that money growth will
resume. There is no way for us to know, or for the Fed to
know, whether Fed interest rate targets are falling fast
enough to assure a resumption of money growth. In terms of
the diagram on page 10 above, if the economy is weaker than
we now expect, the public's demand for money curve will be
shifting to the left. If the Fed does not shift its money
supply curve--interest rate target--down and out, rapidly
enough, money growth will remain low. We must focus on Fed
creation of bank reserves and not on interest rates.
Fortunately, in the statement period ending November 21
total bank reserves were up by $700 million. Reserves
growth must continue if money growth is to resume. The Fed
can control reserves growth accurately if it lets go of
interest rates.
Third, over the longer run there is no reason to
believe that we will see smooth money growth within the
target range. Indeed, there is every reason to believe that
money growth will continue to be volatile. Nothing in the
record over the last decade provides good reason to be
optimistic on this matter. Concentration on interest rates
will assure this outcome in the future as it has in the
past. An improvement in monetary policy, both for next year
and the long run, will require that this fixation on
interest rates be abandoned.
Policy Implications: A Summary
1) Although interest rate smoothing may at times be
advantageous, at times like these it is particularly
destabilizing. If.we are approaching a potential cyclical
peak, a major side. effect of interest rate smoothing is to
increase the risk of recession. Given the historical
evidence that major decelerations in money growth are
associated with cyclical turning points, the Fed should
abandon interest rate targeting and concentrate on
stabilizing Ml growth.
2) From 1965 until 1979, concern for unemployment led
society to be slow to constrain money growth. Now the
situation is reversed and the Fed must not let concern over
Approved For Release 2008/08/20: CIA-RDP85-01156R000100160009-1
 Approved For Release 2008/08/20: CIA-RDP85-01156R000100160009-1
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a potential acceleration of inflation lead to excessively
slow money growth.
3) Concern over inflation ought not to be expressed
in terms of advocacy of a monetary policy of maintaining
high interest rates. Low inflation will yield low nominal
interest rates. A policy of excessively high interest rates
can only yield recession. How. can we know when interest
rates are "excessively" high? The safest standard is the
money growth rate. Our position should be that we expect
the Fed to achieve moderate and steady money growth within
announced target ranges.
Approved For Release 2008/08/20: CIA-RDP85-01156R000100160009-1