(00:00:01) Live broadcasts of public affairs events and proceedings on Minnesota Public Radio is made possible by the public affairs fund including The Grotto Foundation. It's 12 o'clock. (00:00:12) Good afternoon. I'm Austin Sullivan vice president of public affairs at General Mills and a member of the steering committee of Minnesota meeting. It's a pleasure to welcome all of you here today. We also extend a welcome to the radio audience throughout the Upper Midwest listening to this program on Minnesota public radio's. Midday program broadcasts of Minnesota meeting are made possible by the law firm of Oppenheimer wolf in Donnelly with offices in Minneapolis. St. Paul and other major cities throughout the United States and Europe. Minnesota meeting is a public affairs Forum which brings National and international speakers to Minnesota. members of Minnesota meeting represent this community as leaders from business government Academia and the professions today Minnesota meeting is pleased to present Martin feldstein the George F Baker professor of Economics at Harvard and former chairman of the Council of economic advisers who will discuss the trade deficit and the dollar Dr. Feldstein also heads the National Bureau of economic research a private nonprofit research organization that has specialized for the last 65 years in producing nonpartisan and highly influential studies of the American economy. Dr. Feldstein has had a major influence on US economic policy throughout this decade. He chaired the Council of economic advisers from 1982 to 1984 and continued to have the ear of the president throughout the Reagan years. He continues this tradition as a principal economic advisor to President Bush. He was graduated summa cum laude from Harvard College in 1961 received his Doctorate from Oxford University in 1967 and became a full professor in the Harvard economics Department two years later. Dr. Feld Stein's research and writing which has been prolific has focused on problems of the national economy and Public Finance. He is a fellow of the American Academy of Arts and Sciences the econometrics society and the National Association of business economists as well as serving on several major corporate boards. Following his presentation questions will be addressed from the audience. Please use the cards at your table to jot down questions for discussion. Gary Gilson and Sonia Cairns will move among you to manage the Q&A session. And now please join me in welcoming. Dr. Martin feldstein. (00:03:07) Thank you very much. I'm delighted to be here in Minneapolis and to have this opportunity to talk with you about what I see as the future developments of the American economy. I want to look beyond the immediate future. I want to look Beyond what's going to happen to the stock market next week or the GNP next quarter to see what the major Trends are that are going to influence the performance of the economy in the 1990s. (00:03:35) I'll begin by talking about the problem of our trade deficit the (00:03:39) dollar and our International economic relations, but then I want also to discuss related issues the budget deficit and the larger question of our national savings rate and also the problems of inflation and the business cycle. I think that the decade of the 1980s has been marked by serious problems in all three of these areas and to summarize in a word the message that I bring you today it is that the 1990s are likely to be substantially better on all three counts. Let me start with the trade deficit if we go back to the beginning of this decade the trade deficit was not a problem. We were essentially in trade balance. In fact, the earnings that American investors had on their foreign investments were so large that they outweighed the interest and dividends that we paid to foreigners and we were in a position to add to our stock of Investments abroad. We had a current account Surplus, but by 1984 all of that had turned around and the trade deficit had increased to more than three percent of GNP our current account deficit are Science in other words on foreign capital from the rest of the world was more than a hundred billion dollars a year and was increasing rapidly. I don't have to tell you in this part of the country that manufacturing and agriculture were both very badly hurt as a result of that sharp increase in the trade deficit. The deterioration of our trade deficit led to a lot of self-criticism people talked about the inadequacy of American management. They talked about the poor quality of our school system. They talked about our Labor Relations. There's obviously truth in all three of those problems. But whatever the truth is those problems didn't arise suddenly in the first few years of the 1980s. They were not the cause of the sharp increase in the trade deficit. What was that? The primary reason was the increase in the value of the dollar the dollar Rose in real terms by sixty percent between the end of the 1970s and its peak at the beginning of 1985 and I don't have to tell you that when your prices go up by 60% relative to the competition. It's very hard to maintain market share. And so of course American firms lost market share in the rest of the world our Imports declined and lost market share here at home as exports surged. Now the sharp increase in the dollar wasn't the only reason for our big increased in our trade deficit. In addition to that with three other principal factors first, what happened in Latin America as the Latin American debt problem became very clear 1982 Latin American countries could no longer get credit to finance imports from the rest of the world. And so they had to go from being major importers to being major exporters. And since the United States has a large share about 40% of the Latin American Import Market that hurt our exports to the rest of the world. The second major factor was what happened in agriculture our agricultural markets abroad dried up not only because of the change in the policies in Europe The Dumping by the European economic community of agricultural products, but also because of the great improvements that occurred in agriculture in China and India and elsewhere and finally there was a major change in the late 70s and in the early 1980s that continues today in the competitiveness of the newly industrialized countries of Korea Taiwan Singapore. Those Knicks have become much more formidable competitors than they were a decade ago. So all of those contributed to our trade deficit, but nevertheless it was the sharp increase in the dollar. That was the primary reason for the deterioration of our trade balance. When the dollar came down as it did beginning in February of 1985 the trade deficit moved in the same direction, it improved the dollar came down over a two-year period by about two-thirds of the amount that it increased. As a result, we saw a sharp improvement in our trade balance between the middle of 1986 and the middle of 1988 exports increased by 40% in that two-year period our trade deficit dropped by 25% Andy just between 1987 and 1988. We saw the exports from the United States to the rest of the world rise by some 70 billion dollars that accounted for half of all of the real growth of GNP between those two years. Unfortunately though the dollar stopped falling in the beginning of 1987. And since then it is moved rather erratically today. The dollar is higher than it was two years ago on a worldwide basis. The result is unfortunately that American firms are now losing competitiveness in World Markets. Result of all of that is just what you'd expect. Our exports are declining the merchandise trade deficit jump to almost eleven billion dollars in the month of the most recent month giving us an annualized rate of trade deficit of more than a hundred and thirty billion dollars higher than it was last year today the GNP preliminary numbers for the third quarter were announced and they indicated an increase in the real deficit of twenty five billion dollars annual rate from where it was just a quarter ago at the current level of the dollar. I have no doubt that our trade deficit will continue to deteriorate for the rest of this year and 1990 and Beyond. Indeed with the dollar at its present level the u.s. Becomes dependent upon the inflow of foreign Capital an inflow that will expand explosively over the next few years. Not only is our trade deficit grows. But as we have to meet the interest and dividends in our ever growing debts to the rest of the world debts, which today exceeds some 600 billion dollars on a net basis. That's why when the finance Ministers of the leading industrial countries the G7 group met a few weeks ago. They said in their communique that the dollar is now too high to be consistent with long-term fundamentals. They backed up that conclusion with massive intervention for about 10 days time to catch the financial markets attention to make it clear that these weren't just words and as a Prelude to the change in monetary policy. Which is now taking place Germany increased its short-term official discount rate. Japan has done the same thing and the Federal Reserve has begun to he's gradually bringing down short-term interest rates in this country. I believe more of that is in store and the result has been some decline in the value of the dollar in the last several weeks. I expect the dollar will continue to decline. I think that in real terms the dollar over the next two to three years will fall by some 15 to 20% the dollars short term Behavior cannot be predicted. It's like the stock market is volatile investment vehicle, but I think the fundamentals are that over the next two to three years. We will see a 15 to 20 percent real decline in the dollar. That means that the dollar vis-à-vis the yen in today's prices would be down at a hundred and fifteen 220 yen to Dollar in comparison to the 141 Yen to the dollar current exchange rate moreover. I emphasize the word real because unfortunately the inflation rate in the United States is higher and is likely to remain higher than the inflation rates in Japan and Germany over the next few years. And so just for us to stand still in terms of competitiveness. The dollar has to come down gradually year by year by an amount equal to the difference between our inflation rate and the inflation rates abroad over the next three years. That should add roughly another 10% to the fall in the value of the dollar relative to the Japanese Yen and the German Mark as a result. I think that by the early 1990s by 1992 or 1993. We should expect to see the yen-dollar rape at about 100 yen to the dollar with corresponding. Klein's in the dollar relative to the German Mark and other currencies the result of the decline of the dollar will be an increase in our exports and a reduction in our Imports. I believe the United States is going to move from its current substantial trade deficit back to trade balance or perhaps even Trade Surplus by the mid-1990s that will still leave us with a substantial capital inflow from the rest of the world needed to finance not a trade deficit but the interest and dividends on the obligations that were building up to the rest of the world that capital inflow, even if we are in trade balance by the mid-1990s is likely to be about one percent of GNP. Of course a return to trade balance will have very favorable effects on manufacturing industry in the United States. Let me comment on three aspects of this Improvement in the trade balance. First of all our ability to cut the trade deficit does not depend upon a further reduction in barriers to Imports and foreign countries. Of course, it would be good if Japan and other countries did reduce some of their barriers to American products, but experience has shown repeatedly that a lower dollar will lead to increased exports and reduced Imports regardless of what happens to foreign barriers. We don't have to fear that a lack of Market opening elsewhere will leave the US with a massive trade deficit second point I would make is that an improvement in the trade deficit shouldn't be confused with an improvement in productivity or an improvement in our standard of living. If our trade deficit does decline over the next few years as I expect that will no doubt make us feel better and improve our self image. But in fact the volume of goods and services available in the United States will actually be lower because more of them will be being shipped abroad and we will be receiving fewer imports from abroad we will see an improvement in the merchandise trade deficit because the dollar comes down and not because of any special surge in productivity in the United States just as I said a few minutes ago that it would be wrong (00:15:28) to blame the (00:15:29) increase in the trade deficit early in the 1980s on some failure of productivity here. It would also be wrong to think that the improvements that will occur in our trade deficit are a reflection of improvements in productivity to raise productivity to raise our standard of living we have to increase capital accumulation. We have to have better trained workers. We have to adopt new technologies and I'll come back to that in a minute, finally and more worrisome the reduction in the trade deficit means a reduction in the inflow of foreign funds that are now financing investment in the United States this year. The inflow of foreign Capital will be about a hundred and thirty billion dollars or more than two percent of GNP. The such will finance about a third of all of the net investment in housing and plant and equipment in the United States by 1993. I expect that that will be down from the more than two percent of GNP today to less than one percent of GNP. Therefore, they will be less funds available in the United States to finance investment in plant and Equipment unless we increase our domestic saving rate and that's the subject to which I want to turn now. I think the second major problem of the night. 1880s has been the low rate of national savings nice a national savings to include the savings of households businesses and governments available for investment in plant and equipment and in housing and as well as investment abroad the 1960s and the 1970s. We had a (00:17:15) national savings rate of about seven (00:17:18) percent of GNP (00:17:20) six percentage points of that state here at home one percentage Point went abroad investing in American businesses elsewhere in the world (00:17:30) in the 1980s that savings rate has simply collapsed. Let me give you some numbers. Private savings the savings of households businesses and state and local governments really non Federal Savings (00:17:43) in the 60s and 70s average nine percent of GNP (00:17:47) last year. It was only six percent of GNP fell by 3 full percentage points. The government deficit which averaged about two percent of GNP in the 1960s and 70s Rose to a peak of six percent of GNP in the mid-1980s, but fortunately has come down to three percent of GNP last year. But if you look at last year with a six percent of GNP private saving rate and three percent of GNP being (00:18:18) Borrowed by the federal government (00:18:20) that left us with national Savings of only three percent of GNP (00:18:25) now fortunately (00:18:26) investment didn't collapse to three percent of GNP because we did have an inflow of capital from the rest of the world. That's the flip side of our bad trade deficits but investment definitely was lower than it otherwise would have been and since I believe the inflow of capital from the rest of the world is going to shrink. I fear that unless we have an increase in private savings and a reduction in our budget deficit looking. Head investment will Decline and therefore the productivity growth that results from that investment the higher standard of living that results from that investment will also decline. What are the prospects though for future reductions in the budget deficit and future increases in private savings? I think they're actually pretty good not automatic. They'll take Serious positive decisions in Washington, but I think the prospect for the 1990s is much more favorable than the years. We've come through. Let me look first at the budget deficit. The recent budget Fiasco is a reminder that the gramm-rudman-hollings legislation as work far from (00:19:39) perfectly to (00:19:41) achieve the annual targets. They've had to use a combination of phony forecasts and accounting gimmicks, but nevertheless there has been real progress. I (00:19:52) said earlier (00:19:53) that the deficit is come down from six percent of GNP in 1985 to three percent of GNP in 1989 (00:20:01) for 1990. The year's (00:20:03) budget. The Congress is currently wrestling. We're not going to see an actual deficit of a hundred to a hundred and ten billion dollars were more likely to see a hundred and thirty to a hundred and forty billion dollars, but even so that'll be a ten percent real reduction in the size of the deficit from 1989 and it will (00:20:22) bring the deficit down below two and a (00:20:25) half percent of GNP (00:20:27) in 1991. The gramm-rudman target is 64 billion dollars. They're not going to reach (00:20:33) 64 billion dollars, even if they reach it on paper when the dust settles and we examine what actually happened the deficit will be larger probably a hundred billion dollars, but at a hundred billion dollars, it will be less than two percent of GNP and therefore back to the level below the level of the 1970s. I think the deficit remains a very (00:20:57) serious long-term problem, (00:20:59) but the crisis levels the real dangers of a sudden collapse of investment because of inadequate savings that we had in the mid-1980s. I think are now a thing of the at least temporary past. I believe in the 1990s. It is possible that we will move to budget balance and even move into Surplus because of the very large Social Security fund accumulation. I certainly think that it is very likely that the deficit in the 1990s will be lower than the two percent of GNP that we had in the (00:21:33) 1970s. (00:21:36) What about private savings Savings of households and businesses and I'll count state and local governments in that same same basket. That is as I said a moment ago a more serious problem from a nine percent level in the 1960s and 70s that collapsed last year to six percent and therefore that three percentage Point full is three times as large as the increase in the budget deficit since the 1980s began. Most of that has been a fall in personal savings and household savings, although business saving has contracted a bit fortunately that sharp fall in household savings was due primarily to Temporary factors and the recovery in our personal savings rate is already underway personal savings as a share of household disposable income reached a low of just three percent in 1987 by (00:22:35) 88 it (00:22:36) was at four and a quarter percent in the first half of 1989. It was running at five and a half percent. I am relatively optimistic that that will continue over the next several years and bring us back to at least the 7% personal savings rate that we had in the 1960s and 1970s and therefore that total private savings including the savings of businesses and state and local governments will get back to the nine percent level that we had in the past. Let me admit that that Outlook is clearly uncertain but nevertheless I think that a return to a level at least as good as the 1970s is very likely even so though that will leave us with a very low savings rate by World standards with seven percent net National savings rate in the United States were only a little more than half of the savings rate in Germany or France. And significantly less than half the savings rate in Japan. So we are passing up important opportunities to save and invest and to raise our level of economic growth nevertheless. It will be a more favorable situation than we had in the 1980s and probably then in the 1970s changes in government policy can help to increase the private saving rate primarily changes in tax rules which today discourage saving and encourage borrowing. Fortunately, I think that there is a fundamental change in attitude towards saving taking place in Washington. And that kind of change in attitude is the first step to a change in policy for a long time National policy was dominated by what I would call a fear of saving according to the old Keynesian theory of people increase their savings. They'll be inadequate demand for consumption goods and that'll lead to a recession now it's recognized that that isn't applicable to our economy as it functions today now an increase in savings would finance an increase in investment in plant and equipment and in housing in other words an increase in savings would represent a shift in demand from consumption Goods to investment Goods. There's very serious interest within the administration the highest levels in the White House and in the treasury as well as in the Congress in developing mechanisms for increasing saving and I think next year's legislation. Is likely to bring an expanded series of Ira options and I think the evidence on that is very clear that they were quite successful in stimulating savings among medium and lower-income households. And then in addition to that we will see lower capital gains tax rates. I believe that in the 1990s private savings rates will therefore be at least as high as they were in the 1970s and since the budget deficit will be lower as a share of GNP then it was in the 1970s the net of it all the national savings rate will be greater than it was in the 1970s moreover in this is very important in the 1970s. We were Capital exporters One percent of GNP is worth of capital 1/7 of all of our savings were going abroad in the 1990s. We're going to continue to be net recipients of capital from the rest of the world again on about that same order of magnitude about one percent of GNP. So Instead of losing one percentage point of our savings to the rest of the world. We will be net gainers of one percentage point and that will turn the pool of investable funds within the United States into a higher level that greater pool of savings. The United States should mean lower real interest rates, which will be a stimulus both to new investment in plant and equipment and also to higher price earnings ratios on stock market equity. Let me turn finally and briefly to the third major problem of the 1980s. And that is the combination of high inflation and a serious recession the 1980s began with the worst inflation of the post-war period and immediately that was followed by the worst recession of the post-war period the remember back to 1980 and 81. We had more than 10% annual increases in inflation and many Americans feared that we were on our way to spiraling out of control in the same way that the Latin American economies. Have we then had a very painful recession in which the unemployment rate Rose to 10% that had the effect of driving the inflation rate down very quickly so that by 1983 the inflation rate was only three percent. One of the future are we going to be on that kind of roller coaster again? What can we look forward to better policy and better performance? I'm quite optimistic again. I wouldn't want to bet the ranch on it. But I think we are going to avoid both of those excesses when it comes to the 1990s. Remember that the inflation rate in the United States in the 1950s and the 1960s was less than 2% inflation rate really only began to take off the late 1960s and 1970s inflation is not inevitable. It comes about as a result of policy mismanagement policy mismanagement that allows Demand to occur to accede to outstrip supply (00:28:23) when inflation (00:28:24) increases the primary culprit to whom we should turn is the Federal Reserve either because they have initiated an easy money policy that caused a man to exceed Supply or because they failed to offset and increase in demand from some other source and therefore allowed demand to exceed Supply. So the outlook for inflation in the 1990s is really the outlook for Federal Reserve policy today. The Federal Reserve faces a very difficult situation inflation has been rising for the last few years was three and a half percent in 1987 Four and a quarter percent in 1988 and nearly 5 percent in the first half of 1989 the Federal Reserve Alan Greenspan in particular one to bring the Rate down but they want to bring it down gradually over several years without permitting the economy to fall back into recession. Their diagnosis is that the situation today is very different from what it was in the double-digit inflation is of 1980 and 81 and therefore the inflation is curable without the painful medicine that we had at that time. So their strategy is to control the growth of money to control interest rates to bring about slow growth and I emphasize both of those words equally slow and growth they want growth to continue. They want GNP to keep Rising but they want it to happen slowly two to two and a half percent that will mean that employment will continue to grow even though the unemployment rate will creep up a little bit capacity utilization rates will come down a bit and as a result inflation will fall. (00:30:14) Will that (00:30:15) strategy work? Well, if you took the news that came out this morning you would say so far. It is working the GNP growth real growth and the first in the third quarter the quarter that's just ended has slowed to two and a half percent and the inflation rate has come down to two point nine percent. So the Federal Reserve can feel that on the first measurement they're doing very well. Will it actually succeed though quarter after quarter. (00:30:44) Will he be able to keep (00:30:45) low growth and declining inflation if they do so it'll be the first time that we have seen an actual significant reduction in inflation without a recession at this point and despite the successes of today. I think there is less than an even chance that they will succeed in their goal of getting rid of inflation while keeping the economy away from a session. I think the most likely thing is that inflation will (00:31:13) remain in the roughly four percent range. (00:31:17) For the foreseeable future for the next two or three years. I think it's also possible that despite the feds desire to avoid a recession. We will fall accidentally intercession nevertheless. I think that the FED is pursuing the right strategy it may work and if it does work, we will get low inflation without recession. It is certainly better than the alternative of an explicitly engineered recession with all of the pain and all of the waste that that would involve (00:31:48) if in a few years the FED strategy hasn't (00:31:51) worked if we still do have inflation rates or four or five percent then the FED will again face the difficult policy choice, but I think we will not see in the 1990s repeat of the problems of the late 1960s and 1970s (00:32:09) of an inflation rate that spirals up to double-digit levels. Why am I optimistic for two reasons first (00:32:16) because that double-digit inflation of 1979 through 1981 and the painful recession that had to follow it taught policymakers an important lesson about the dangers of increasing inflation and the difficulty of bringing it down and second at a somewhat more technical level. I think the Federal Reserve Governors and staff Now understand that they made a mistake in the 1970s or their predecessors made a mistake in the 1970s when they tried to Target too low a rate of interest in too low and unemployment rate and by setting impossibly low targets for that. They started an inflation spiral. Now the FED knows that was a mistake and it pays far more attention to the monetary Aggregates and to nominal GNP an approach that I think will greatly reduce the risk of increased inflation in the future. So I think the 1990s will see an inflation rate that gradually comes down below 4% either because of the success of the fed's policy or because at some later point they do either explicitly or by accident find the American economy in recession. It could be that we (00:33:35) will return before the end of (00:33:36) the decade to the very low inflation rates of roughly (00:33:39) 2% that we had on (00:33:41) average in the 1950s and 1960s. In any case by avoiding the accessories of inflation. We should also be able to avoid a repetition of the deep recession that we had to suffer through as this decade began. Let me be clear. I'm not saying that the business cycle is dead. But only that as I look forward, I think we see milder business cycle fluctuations than we did in the past. In short then I think the basic economic conditions of the 1990s are likely to be much better than they were in the 1980s a decline in the dollar that will cause the trade deficit to shrink and become a trade surplus (00:34:27) a decline in the (00:34:28) budget deficit and an increase in personal savings that will together raise our national savings rate and therefore permit us to finance greater investment in productivity increasing plant and equipment and an inflation rate that will decline giving us mild or cyclical fluctuations as the Federal Reserve policies reflect the painful lessons of the 1970s and 1980s. All that happens the 1990s will be a decade of excellent economic performance. Of course, it won't happen automatically. It will require sound policy Decisions by officials in the administration at the fed and in the Congress. Let's all hope that they have the wisdom and the courage to do what needs to be done. Thank you very much. (00:35:28) We've been listening to dr. Martin feldstein who occupies an endowed chair at Harvard University as a professor of Economics former chairman of the Council of economic advisers in the Reagan Administration. He is joined here with 225 luncheon Partners at the Minnesota meeting at the Holiday Inn on the Nicollet Mall in Downtown Minneapolis first question, please (00:35:51) Dr. Feldstein what can the Latin American countries due to control their hyperinflation and what effect will that have on our prospects for the 90s perhaps the key thing that they have to do is to cut some of the budget deficits that they have as a result of very inefficient subsidies to State Enterprises because they have to finance their budget deficits by printing new money. They have created not just double digit but triple digit rates of inflation in many of those countries if they bring their budget deficits under control and therefore their inflation under control, they'll have healthier economies better able to service their external debts, including the debts to our banks and also better able to engage in trade which will help our exports to that region. We're beginning to see some significant progress in that area. Mexico is an example of a country that has really Turn the corner and is pursuing much Sounder policies now than they did a few (00:36:54) years ago. There are some apologists that say that the federal debt is no more difficult to manage today than it was 10 20 30 years ago. Would you care to comment on that? (00:37:09) Well The federal debt today is as a share of GNP back to the levels that we had just about 30 years ago, then came down significantly and has been rising through the 1980s. I don't think that the problem is one of managing the public debt. I think the real question is, what does that high public dead due to our future and what it does is (00:37:36) substitute for (00:37:38) real investments in plant and equipment that raise productivity that increase the standard of living in the economy. It's the public debt the public borrowing substitutes for investment in housing and that lowers the quality of our housing stock. So it's not the question of whether we can manage it. We can manage it. The sad fact is that that accumulation of trillions of dollars of debt has diverted resources that would have been better spent in real investments in plant and equipment and in housing. (00:38:10) Dr. Martin feldstein comes to you on the station's of Minnesota Public Radio from the Minnesota meeting (00:38:15) should the Social Security Surplus be counted as when calculating the federal budget deficit or are we simply deceiving ourselves regarding the mono progress? We're making (00:38:26) well the numbers that I quoted as I spoke included the Social Security Surplus as part of the revenues of the government and other words. The deficit was net of the Social Security Surplus. And I think that's the right way to think about the near-term pressures pressures between now and throughout the 1990s on our Capital markets. The receipts that come into the Social Security program do help to finance other investment in the economy do help to keep down interest rates, but for the long term, you have a very important point. We are not actually adding to our Capital stock as originally intended when the Social Security Surplus was built into the law in 1983. And therefore when the baby boom generation begins to retire off 30 years from now, we're going to have some very serious problems because we have not made adequate provision in advance. (00:39:27) Act they'll stand how have things changed on the Council of economic advisers since your day and how do you see those today as they relate to the Federal Reserve board? (00:39:39) Well, I'm not sure that they have changed all that much. I see my successor Michael boskin fairly frequently. Mike. Boston is a very good Economist. He comes to the Council of economic advisers from Stanford University. He has to first-rate economists who are the other members of the cea and they seem to be engaged in many of the same issues many of the same problems that I and my colleagues were engaged in at the time. The FED of course is an independent agency. They make their own judgments, but the cea chairman and the FED chairman do talk together from time to time in a private way about their judgments about the economy in my time. It was Paul volcker and now Mike Boston talks with Alan Greenspan. I think the fact that the Administration has a very senior Economist who has direct access to the president and can speak on an equal level with cabinet members is a great strength of our economic system and one of the great virtues of having a (00:40:39) cea Dr. Feldstein, why did the (00:40:44) dollar go back up from 1987 when we had it right where we wanted it. I wouldn't even say we had it right where we wanted it. I would say that in early 1987. It was coming down and it still had somewhat further to go to get it down to a level that would allow us to reach trade balance. But the Japanese were very worried in the beginning of 1987. They saw a major recession in Japan looming because of the sharp increase in the value of the Yen and their loss of competitiveness. The Europeans were also quite worried and the the Fed was beginning to worry that the sharp fall in the dollar might be adding to inflationary pressures here. And so an agreement was reached to try to stabilize the dollar and the Americans raised interest rates the FED raised interest rates vary substantially throughout Seven until the stock market crash the Japanese and the Germans lowered interest rates pursued an easier monetary policy and also in a sense bought up all of the current account deficit all of the government borrowing on the rest of the world that year about a hundred billion dollars worth absolutely unprecedented. And so the result was to make dollar Investments more attractive to private investors by pushing up interest rates here relative to abroad and to substitute government borrowing government buying rather of that debt for usual private demand and the combination was enough to keep the dollar High until the end of 1986 1987. Then there was a temporary dip again in 1988, but I won't take your time and the audience is time to take a step by step. But since you asked why it turned around and early 87, I think that was it a major and I believe in retrospect mistake. shift of government policy on all three (00:42:45) countries (00:42:54) I think more Congressional control over the Federal Reserve would be a mistake. I think that the Federal Reserve is the agency that has to do tough things occasionally and they have to have the freedom to do that. Ultimately. The Federal Reserve is accountable to the Congress if the Federal Reserve is seen to be performing badly the Congress can step in and demand different things of it. But the Congress wisely gives it the discretion to do some of the tough things or heaven knows where our inflation rate would be today. So I think there is enough potential check on the FED today without putting political Representatives on the (00:43:38) Federal Reserve board or in other ways further hamstringing their up their operations. (00:43:44) Back to the dollar if the Federal Reserve policy on inflation is is inconsistent with the need for a lower dollar and secondly isn't the isn't a lower dollar a dozen the lower dollar add more to inflation than it does to (00:44:05) growth lower dollar lower dollar. Did you want to add something if the dollar is already cheap on a (00:44:12) purchasing power parity basis. (00:44:14) You've got three questions in there. That's let me let me deal with two of them and maybe come back to the purchasing power issue. If somebody else wants to raise it. The falling dollar does add a little bit to inflationary pressure, but very little we only import about 10% of total spending in this country and therefore a ten percent decline in the dollar even if not offset by Anything else would only add about 1 percent to the price level so we can live (00:44:49) with that decline in the dollar without it (00:44:52) upsetting the basic goal of bringing inflation down over the next several years might come down slightly more slowly than it otherwise would but we can (00:45:00) certainly (00:45:03) live with that does the FED have to ease money to make that happen? I don't think so. I think that anybody who now looks at the rates of return available on dollar bonds and on say German bonds, I think would conclude (00:45:18) that there is not the (00:45:20) extra rate of return on dollar bonds to make it worth bringing money into this country. The difference is only about a half a percentage point now down significantly from the to and not too long ago three percentage Point Gap. So interest rates are so close. Now in Germany has a massive trade surplus while the United States has a massive trade deficit I think investors Is are going to say more and more. We cannot take the risks of buying dollar bonds because the full that is likely to occur at some point in the dollars value will more than outweigh the very small extra interest that we get in the United States. I think as the trade figures begin to come out over the next few months and investors around the world realize that at this level purchasing power parity notwithstanding at this level the dollar (00:46:16) cannot the trade deficit cannot shrink. We will see a further decline in the dollar as investors move away from it. (00:46:26) Elementary question, how do you define a recession and if we were to have one how deep do you think it might be (00:46:33) the National Bureau of economic research which I am the president (00:46:37) has for historic reasons had the surprising responsibility of defining recessions and the (00:46:46) little shaded charts that you see in the newspapers and the magazines are the dates for that shading a determined by a (00:46:53) committee of Economist at the National Bureau of economic research. What do we (00:46:58) do? There is no magic formula. There is no rule of thumb some people say 2/4 decline in GNP. That's right some of the time and not right others. The broad definition is that it has to be a deep sustained and widespread downturn not a single industry not for a single quarter. It's (00:47:19) got to last (00:47:20) for a while and it has (00:47:22) to be Broad. And so we look at a wide range of indicators. (00:47:25) What happens to employment what (00:47:27) happens to Output in the economy? And so on if we do have a recession now, is it likely to be deep? I don't think so. The reason that the recession (00:47:36) was very deep in 19 (00:47:40) in the first part of the (00:47:41) this decade ending in November of 1980 to 1981 and (00:47:45) 1982. Was that the FED felt that we needed a deep recession to get inflation (00:47:52) cured. And since we're now in a situation where the (00:47:55) inflation rate is low, I think that Federal Reserve policy would work to prevent a decline in the economy from becoming a deep recession. (00:48:05) You're listening to dr. Martin feldstein at the Minnesota meeting on the Stations of Minnesota Public Radio. Your presentation was excellent, by the way, and I love your tone of optimism something that hasn't been brought forth. It's interesting to note that many foreign countries as well as major foreign corporations are starting to make very large charitable contributions to charitable entities within the United States as well as entering into a contractual arrangements with major universities to do extensive research programs within the United States. You see this as having any significant impact on the trade deficit in the balance of so forth. (00:48:47) You know the amounts are just although they may be significant in terms of particular institutions. The amounts are small in comparison to a hundred and twenty billion dollar trade deficit. (00:48:58) Dr. Feldstein what effect will the growing numbers of illiterate and semi-literate people across the country have on us productivity in the 1990s (00:49:08) it is of course a very serious problem and when I talk to people and Industry, it is probably the problem that comes up most what are we going to do to improve our educational resources? It's clear that in the last decade there has been a major shift in the skill requirements in the skill rewards in our economy. Ten years ago the gap between what a college graduate received and what a high school graduate or high school dropout received was much smaller than it is today as a result of changes in technology and changes in the character of American industry education literacy numeracy are much more important than they were before. So I think it's very important that our state's and our local governments deal. with that problem in order not only to raise National productivity, but to provide a way of closing the gap between the incomes of the lower groups and the higher groups in our income distribution. Dr. Feldstein how successful will the Eastern Europeans and Soviets be in implementing Market mechanisms in their economies. Well, I was in the Soviet Union few times earlier this year and while I can't speak from experience with the Poland or Hungary. I came away from the Soviet Union very depressed. Originally. I felt that their plans for economic restructuring were very hopeful but I'm afraid they've gotten themselves off on the wrong foot in they have created substantial excess Demand by very large budget deficits being financed by printing money. They have created inflationary expectations in the economy. The result is prices to the extent that they are decontrolled or Rising very rapidly and at the same time they're great shortages of all other Goods because this excess demand cannot Press itself in higher prices my sense is that all of the Soviets understand the changes that ultimately have to be made they are not capable politically of making the kinds of changes that are needed in the near term. They're not capable of bringing down their budget deficit through higher taxes and cuts and subsidies. They're not capable of raising interest rates to induce the Soviet citizens to hold onto the large savings balance is that they have and therefore they're not going to be able to have the price reforms to a move to a deregulated economy as they had hoped as recently as six months ago. So I'm quite pessimistic about the prospects for reform in the Soviet Union. How would you say that abandoning Star Wars would affect our economy. Oh the amounts again are very very small the more generally the reductions in defense spending that we can expect as a result of improved relations with the Russians, maybe a few billion dollars. That's a favorable step in terms of our budget deficits, but the amounts are really quite small. Dr. Pearlstein this morning. There was an (00:52:33) article in the Wall Street Journal regarding the (00:52:35) Japanese firms plowing eighteen to twenty percent of their their profits back into modernization. If American firms have to rely on borrowing to do that. (00:52:46) How will that play out in (00:52:48) terms of the dollar (00:52:50) and the trade deficit and when might we expect that well the Japanese are much more formidable (00:52:56) investors in plant and equipment and we are the sad fact is that your pan with about half the size economy that we have are (00:53:04) investing as much this (00:53:06) year as we are in new plant and (00:53:08) equipment and yet the problem is not the ability to plow back versus the need to borrow. Japanese firms are much more highly (00:53:17) leveraged than we are. The real problem (00:53:20) is a national pool of savings are National Pool of savings. As I said during my remarks I think will be higher in the next (00:53:30) Than they have been in the (00:53:31) last decade will go up from the previous roughly 6 percent of GNP available to invest at home to about 8 percent of GNP that'll still leave them only half of the level available in Japan. If we don't increase or public and private savings we're going to have much lower levels of investment in plant and Equipment. We're going to have smaller gains in productivity. We're going to lose markets in capital-intensive Industries (00:53:59) doctor feldstein. I want to invoke the interlocutors prerogative and ask the final question. We have a very talented filmmaker in Minneapolis named Bob Thurber who did a documentary for Frontline on PBS recently about infant mortality in Chicago. Our society is unwilling to spend between $400 and $700 for prenatal care for poor mother's if the baby is born alive. We spend twenty four thousand dollars in the first month the first month of hospitalization what kind of political and economic sense does that (00:54:26) make it doesn't (00:54:31) Can you convince your (00:54:32) friends? (00:54:36) Can you convince your friends? (00:54:37) Otherwise, maybe your friends? (00:54:41) My friends are convinced. Thank you doctor feldstein. And there you have dr. Martin (00:54:53) feldstein speaking live at Minnesota meeting today Martin feldstein former chairman of the Council of economic advisers. He is president of the National Bureau of economic research his topic before we got to the question-and-answer session was the trade deficit and the dollar live broadcasts of Minnesota meeting are made possible by Oppenheimer wolf and Donnelly providing commercial corporate litigation and international legal services to businesses in 40 countries around the world.