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SECOND MEETING ON THE CONDUCT OF
MONETARY POLICY
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
NINETY-FIFTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE CONDUCT OF MONETARY POLICY
PURSUANT TO PUBLIC LAW 95--188
APRIL 24 AND 25, 1978
Printed for the use of the Committee on Banking,
Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
28--083 0
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Federal Reserve Bank of St. Louis
WASHINGTON : 1978
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
WILLIAM PROXMIRE, Wisconsin, Ohairman
JOHN SPARKMAN, Alabama
EDWARD W. BROOKE, Massachusetts
HARRISON A. WILLIAMS, JR., New Jersey JOHN TOWER, Texas
THOMAS J. McINTYRE, New Hampshire
JAKE GARN, Utah
ALAN CRANSTON, California
H. JOHN HEINZ III, Pennsylvania
ADLAI E. STEVENSON, Illinois
RICHARD G. LUGAR, Indiana
ROBERT MORGAN, North Carolina
HARRISON SCHMITT, New Mexico
DONALD W. RIEGLE, JR., Michigan
PAULS. SARBANES, Maryland
KENNETH A. MCLEAN, Staff Director
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Federal Reserve Bank of St. Louis
JEREMIAH
s. BUCKLEY, Minority Staff Director
STEVEN
M.
ROBERTS,
(ll)
Ohief Economist
CONTENTS
LIST
OF
WITNESSES
MONDAY, APRIL
24
Page
Otto Eckstein, president, Data Resources Inc., Lexington, Mass_________
Leonard Santow, advisor to the board and senior vice president, J. Henry
Schroder Bank and Trust Co., New York___________________________
Donald D. Hester, Economic Department, University of Wisconsin______
Thomas D. Thomson, first vice president and chief economist, Detroit
Bank and Trust Co______________________________________________
Joan G. Walters, chairman, Department of Economics, Fairfield University, Fairfield, Conn______________________________________________
TUESDAY, APRIL
3
15
44
79
97
25
G. William Miller, Chairman, Board of Governors of the Federal Reserve
System_________________________________________________________
128
ADDITIONAL STATEMENTS AND DATA SUPPLIED FOR THE RECORD
"Appropriate Monetary Policy," statement by Dr. Jack Carlson, vice
president and chief economist, Chamber of Commerce of the United
States__________________________________________________________
Library of Congress, Congressional Research Service, Federal Reserve
System Targets and Macroeconomic Measures: Selected Data Series_____
"Monetary Policy at a Crossroad," statement by Ronald H. Marcks,
attorney from Lincoln, Mass______________________________________
Response to Senator Schmitt request for comments from witnesses on
inflation, productivity, unemployment, and exports-imports imbalance:
Bank of America, A.W. Clausen, president_________________________
Data Resources, Inc., Otto Eckstein, president_____________________
Fairfield University, Joan G. Walters, Ph. D., professor and
chairman, economic department_______________________________
J. Henry Schroder Bank & Trust Co., Dr. Leonard J. Santow _ _ _ __ __ __
Response to a question asked by Senator Proxmire from Dr. Leonard J.
Santow_________________________________________________________
Shadow Open Market Committee, policy statement, March 13, 1978_____ __
202
210
187
195
197
199
201
35
182
TABLES AND CHARTS SUPPLIED FOR THE RECORD
Administration and chamber forecasts_______________________________
Administration record on forecasting_________________________________
Budget estimates__________________________________________________
Business capital spending activity___________________________________
Consumer sector activity _________________________________________ -Data resources forecast of the U.S. economy, April 22, 1978, preliminary___
Debt and income since 1945_ _ _ _ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Deposit turnover and the velocity of money___________________________
Distribution of outcomes for money supply growth MI, 100 simulations,
1978: I to 1979 :L__ __ __ ____ __ __ __ __ __ __ __ __ __ __ __ __ ______ __ __ __ __
D RI boom monitor________________________________________________
Effects of $24 billion tax relief_______________________________________
Effect of 3-month postponement of tax cuts___________________________
Effect of po stponement plus $5 billion cut in personal tax reductions for
1979 and$ 2 billion cut for 1980_____ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
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(Ill)
203
204
23
147
146
5
74
62
10
7
204
8
9
IV
Pap
TABLES AND CHARTS SUPPLIED FOR THE RECORD--Continued
Federal funds rates________________________________________________
Federal funds rates and Federal Open Market Committee targets________
Full-employment budget deficits, 1975-80_ _ _ _ ________ ____ __________ __
Growth in investment in plant and equipment and productivity_________
Growth of deposits at savings and loan associations, credit unions, and
mutual saving banks, monthly____________________________________
Growth of money stock, Ml and M2, quarterly_______________________
Inflation, money supply adjusted; wholesale prices_____________________
International sector activity________________________________________
Investment by 1982 from $1 billion tax relief this year_________________
Legislation enacted during 1977 _ _ _ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Measures of aggregate inflation_____________________________________
Money stoc~ le~els relative to the Federal open market committees longrange pr0Ject10ns_ __ _ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Money supply growth and the Federal funds rate_____________________
Money supply (Ml) growth rates and 2 month Federal Open Market Committee target ranges_____________________________________________
Output, employment, and unemployment____________________________
Past tax cuts sized for the fiscal year 1979 GNP_______________________
Past tax relief for business sized for the fiscal year 1979 GNP___________
Past tax relief for direct investment sized for the fiscal year 1979 GNP___
Presidents goals and DRI forecast, 1977-80___________________________
Probabilities for growth of monetary aggregates 1978:I to 1979:I, classified
according to the target range_____________________________________
Prosperity, GNP; money supply____________________________________
Quarterly change in Federal funds rates______________________________
Real business fixed inyestment during business cycles__________________
Recently established M-1 growth ranges and actual M-L______________
Recently established M-2 growth ranges and actual M-2_______________
Recent history of interest rates_____________________________________
Risk ranges from the stochastic simulation___________________________
Selected monetary aggregates since World War IL____________________
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41
42
7
206
40
39
189
149
209
208
148
60
24
42
145
205
205
206
6
12
192
41
207
150
151
65
11
52
SECOND MEETING ON THE CONDUCT OF MONETARY
POLICY
MONDAY, APRIL 24, 1978
U.S. SENATE,
CoMMITIEE ON BANKING, HousING, AND URBAN AFFAIRS,
Washington, D.O.
The committee met at 10 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire ( chairman of the committee)
presiding.
Present: Senators Proxmire, Riegle, Lugar, and Schmitt.
OPENING STATEMENT OF CHAIRMAN PROXMIRE
The CHAIRMAN. The committee will come to order.
This morning we begin 2 days of oversight hearings on the conduct
of monetary policy by the Federal Reserve System. These hearings
are now required by the Federal Reserve Reform Act of 1977 that
was enacted into law last November. Today we will receive testimony
from five very talented economists, and tomorrow Mr. William
Miller, the new Chairman of the Board of Governors of the Federal
Reserve System, shall be our only witness. Chairman Miller's appearance shall mark his first meeting with the Senate Banking Committee
on the subject of monetary policy.
Before we begin I would like to make a few remarks about current
monetary policy and the reporting procedures that are currently
required by law.
·
First, I would like to indicate my disappointment in the apparent
move by the Federal Reserve late last week to further tighten credit
availability by letting the Federal funds rate rise to 7 percent. In my
opinion this comes at a particularly crucial time for our economy
and is not called for by current economic conditions, by economic
conditions that have been forecast for the second half of 1978 and
beyond, or by recent growth in the monetary aggregates. The funds
rate increase seems entirely inappropriate and may be costly to the
economy as the year progresses. The reasons for the increase are not
at all clear, and I hope that we can identify them through these
hearings.
Real economic growth during the first quarter was negative-the
first time that has occurred since 1975. The growth of the monetary
aggregates in the first quarter was near the lower limits of the ranges
established by the Federal Reserve; and in fact, growth in the monetary aggregates has been low on average over the last 6 months. We
may get a "snap-back" in economic activity during the current
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(1)
2
quarter with real growth accelerating, and this may cause money
growth to be somewhat £aster as a result. But after that the outlook
is for slower growth in the economy, perhaps below 4 percent in
real terms.
I£ we consider the monetary aggregate targets of the Federal
Reserve, the current tightening makes no sense. They are well within
the ranges that the Federal Reserve said it was willing to tolerate.
Therefore, it would seem that the Federal Reserve could easily accept moderately faster growth in the near term. This pickup may
take place because of the temporary acceleration in economic activity
this quarter. Moreover, there are signs that even the interest rate
levels we had during the past 6 months were having a dampening
effect on the growth of the monetary aggregates and on the flows of
funds to thrift institutions. Further stringency could create serious
problems for the thrift institutions and the housing market.
I£ we consider the forecasts for economic developments over the
remainder of the year, the increase in the Federal funds rate also
does not seem justified. Monetary policy does not work instantaneously; it takes time to have an effect on the economy. Higher interest
rates now indicate that tighter monetary and credit conditions will
prevail during the second half of the year, and this could further
dampen the economy which is already expected to be growing more
moderately than during_ this past year. Furthermore, although the
outlook for inflation has deteriorated recently, tighter monetary
policy can do little to reduce the type of inflation we find ourselves
shackled with.
It should also be recognized that a tighter monetary policy at this
time may result in demands for more fiscal stimulus later this year
or next year, thus increasing the size of the Federal deficit that is
already far too large. The President has already asked for a $24billion tax cut to take effect October 1. The October 1 timing is
important for it conveys information about the economic conditions
expected by the administration this fall. In fact, the President said
in his Economic Report that:
These tax reductions are essential to healthy economic recovery during 1978
and 1979. Prospects for continuation of that recovery in the near term are
favoralJle. Consumers have been spending freely, and many other economic
indicators recently have been moving up strongly. ·without the tax reductions
I have proposed, however, the longer term prospects for economic growth
would become increasingly poor. Because of the fiscal drag imposed hy rising
payroll taxes and inflation, economic growth would slow substantially in late
1978, and fall to about 3½ percent in 1979.
The mix of monetary and fiscal policies is extremely important. I
favor a mixture that would have less Federal spending and an easier
monetary policy, one that would induce the private sector to invest
in new and more productive capital. Unfortunately, it is likely that
the Federal Reserve's tighter monetary policy will he mismatched
with more fiscal stimulus.
This leads me directly into the short comment I want to make at
this point about the type of information the Federal Reserve provides to the Congress and the public about its policies. Clearly,
information about the desired growth in the monetary aggregates
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3
alone is insufficient to understand what the Federal Reserve's monetary policy intentions are and what they are attempting to accomplish with regard to the economy 6 months or 1 year from now. To
understand monetary policy the Congress must receive from the
Federal Reserve not only its plans and objectives :for growth in the
monetary and credit aggregates-to paraphrase the law-but also its
own quantitative :forecasts o:f where the economy is going over the
next several quarters and how current monetary policy actions will
affect those expected developments. One o:f our witnesses said in his
testimony that the current system does not make economic sense. He
is correct. But I am sorry to say that the Federal Reserve is not going
to volunteer this needed information. They won't even provide it
when Members o:f the Congress ask :for it. The Federal Reserve
claims that such information would make them less "independent."
The truth may be closer to the :fact that it would make them more
accountable :for their actions.
Both the current and the past Chairmen o:f the Federal Reserve
Board have said publicly that they wanted to :foster greater understanding o:f monetary policy. At the same time, both Dr. Burns and
his successor Mr. Miller refused to give Congress any more information about the Federal Reserve's policy strategy and the numerical
economic :forecasts that go with it.
The Congress has a responsibility :for overseeing the actions taken
by the Federal Reserve and that responsibility must be taken very
seriously. "\Ve want to know more about monetary policy, how it
works, and what it means :for the :future. We don't want to take away
the Federal Reserve's independence or their responsibilities for conducting monetary policy. I hope that the witnesses we shall hear from
today will help us to understand monetary policy a little more and
advise us as to the correct monetary policies given current economic
conditions and the economic outlook.
vVe are very pleased to have as our first witnesses Dr. Otto Eckstein,
president o:f Data Resources, Inc., and a pro:fessor o:f economics at
Harvard University and a member o:f the Council o:f Economic Advisers under President Johnson; and Dr. Leonard Santow, senior
vice president and adviser to the board o:f the J. Henry Schroder
Bank and Trust Co.
Gentlemen, we have had an opportunity to read your statements,
and they will be placed in :full in the record. You might summarize
your statements i:f you can in ten minutes or so and then we will
be happy to go right into the questioning.
STATEMENT OF OTTO ECKSTEIN, PRESIDENT, DATA RESOURCES,
INC., LEXINGTON, MASS.
Dr. ECKSTEIN. Thank you, Senator Proxmire. My statement is
rather long and a bit on the heavy side, so I will summarize it, but I
would like to take you through some o:f the tables and charts in the
testimony because that's really what it revolves around.
[The complete statement :follows:]
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4
THE CONDUCT OF MONET ARY POLICY
Testimony submitted to the Monetary Policy Oversight
Hearings of the
Committee on Banking, Housing, and Urban Affairs
United States Senate
by
Otto Eckstein
President, Data Resources, Inc., and
Paul M. Warburg Professor of Economics, Harvard University
Apri I 24, 1978
Monetary policy requires some difficult choices during the next twelve months.
The economy is back on its growth track after a rough winter quarter. The
employment situation hos improved dramatically despite a lack of output growth in
recent months, indicating poor productivity performance. T emporory gains in the
fight against inflation achieved in the second half of last year have been !ost in yet
another winter inflationary bulge and the 1'hard-core" inflation rate seems to be
edging from 6 toward 61/:z%. While the President 1s new anti-inflation measures ore
welcome, the inflation rote is very stubborn.
Will the most recent monetary targets be sufficient to permit the economy to
move, in orderly fashion, toward its potential? Will they raise increased dangers of
accelerating inflation? To aid in your deliberations, my testimony will
(I)
present the current DR! outlook and compare it to Administration goals;
(2)
assess the tax cut and its relation to monetary policy;
(3}
assess targets for monetary growth by means of on elaborate new
stochastic simulation exercise which shows the probability distributions of
the growth rates for MI, M2 and M3 over the next four quarters and relates
them to the economy's performance.
(4)
recommend a policy posture for the monetary aggregates and interest
rotes.
THE OUTLOOK
The first quarter results of the 0.6% rate of decline in real GNP contained one
unpleasant surprise: the $22 .. 6 billion trade deficit (NIA basis) is a serious blow to
our hopes of an improving int-emotional position for U.S. industry and for the dollar.
The $4112 billion trade deficit (Census basis) in February, the largest in our history,
probably is a fluke which will be partially reversed~ The recent measures, including
the limited gold sales and the beginning of the development of on export program,
ore welcome, and have helped to stabilize the dollar's dangerous slide. But if a
quick turn does not occur in the trade results, U.S. international economic policy
will face on emergency situation with which it will have to deal forcefully.
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5
The rest of the first quarter performance con ~e attributed to the disruptions of
the winter. The domestic economy is snapping back very sharply. Retail soles are
advancing rapidly; even auto soles, which hod been sliding for eight months, ore
currently advancing well. Housing starts are again above 2 million. Production
rose a big [ .4% in March and a further big increase ls expected for April.
Purchasing power was slowed much less than sales or production during the worst of
the winter months because the disruptions were too brief to create major layoffs.
As a result, employment rose we!!, helping to create the purchasing power to
support
a moderate
further
advance
in consumer spending.
Business fixed
investment, which was also hurt by the winter, shows signs of resuming large
advances in the second quarter. As a result, the current DR! forecast looks for an
8.7% rate of growth in the current quarter. Table l summarizes the April DR!
forecast.
TABLE I - Data Resources F orecost of the U.S. Economy
April 22, 1978, Preliminary
Yeo rs
l 979
1978
1977
--------------------------------------------------------------------1977
!978
1979
1980
I
197'
IV
Ill
IV
I
II
Gross "-'at Iona I Product ... , ...•...
Real O·P { 1972 Doi lor$) ••••..•••.
lrr,:,t ici I Pr Ice Deflator(%Ch) •••••
A•ol 01 sposoble Income ('!!Ch) .•••.
Saving Rote (-..1 •••••••.••.••• :···
...
Housing Starts(MI I, Uni Is) •••.
Un~Joyment Role (t.l ..•.......•.
Federal Budget Surplus (NIA) .....
Maney Supply (Ml) •••••.••..••••••
Anr,uol A.ote al Change .••••••••
New AA Corp. Ulill!y Rore ('X.) ••••
Nttw High-Grode Corp.Bond Role
federol Fund• Role ('X.J.
Prime A.ate (%} •••••••••
,. ,
···········
..........
19'1.8 19'2.9 2070.5 2123,6 2174 .o 2223 .s 1706.4 raa,.6 2090. 3 2306.S 2567.)
1360.2 1358,3 11a, .o 1402. I 141J.J 1424. I 1274.7 1337.3 IJ'J0.2 1444,9 ISi?.?
,., ,.o ,., "'
,.,
,.,
,.,
,., ,., ,., ,.,
,.,
"'
,.,
"' ,., ,.,
,., ,. ,
,.o
,.,
,., ,.o ,., ,., ,., .o ,., ,.o
-s~.o
LI
1.l
6.l
1.894
t .823
1.781
-46 .o -41.8
·"· J
Money and Interest Rotes
-58.2
2,146
I. 732
-60. t
-57.2
335.3
..............
5.5
5.6
5.1
2.060
5.9
,.2
5.8
1.533
1.967
1.877
1.831
2 .006
7
-49.S
-53,S
-54.5
-34.8
,.,
401.6
,.2
,.,
339,5
349.7
359.2
311,1
6.2
,.8
8.82
8.62
6.75
1 .,a
,.20
a.,1
7.26
a.22
,.1
1s·5.o
5,1
345.7
7.4
8.45
8.18
6.51
7.67
'·"
,.11
8. 7'
6.,o
8.04
8.92
8.60
6.60
7.85
8.3)
s.os
,S.84
COTpOS i I Ion 01 Rec:il
Gross Nollonal Product .. ,,, •••••.
F'iool Soles .•.••.••.••••••••. ,,,.
Tola I Consl.lTfllion •• , •. ···••••••••
Non res. fixed Investment •• , ••••.•
E"quipn-,eol ...•..•• , .••.••••.•. ,,.
Non re,. Construct ion •. ••••••·,,,
Res. Fixed lnvestnwnl, •• ,, •••••••
Exports •• , ••. , •••.•••• ,,,,,,,, •••
l"l)orts ..•• ,, .•• ,, •••.•.. , •••••. ,
Federol Gover...,,.nt., ••••• , •••••••
S tote ond Locc:il,, •.
5-)
(N'
8.86
7 .07
8.13
...
8,7
J.7
5.2
17.8
-1B.6
J.5
l.0
),2
,.2
5.7
8,9
,.2
-2.0
10.1
17.7
-7.8
16.2
16.8
J.0
5,1
8,61
5.7
JJ5.3
7,8
355.0
l75. I
5.7
7.1
8.33
8.o,
5.54
6.82
,.01
8,80
7.00
8,09
,.01
8.10
6.71
7.,4
!I.JS
!J.04
1.19
8.2'
Annual Rotes al Chonge
,., -o., ,.,
,.o
,.o
'·' ,.,
,.,
,.,
,., ,.,
,.,
,.,
,.,
-s.,
,.,
,,.o..
- ll.2
,., ,.1 ·-•
o.o
-1.4
-0.3
6.2
8.)
5.6
7.7
7.3
8.7
-4.8
8.8
3.8
2.5
J.2
l.2
-7.J
3.8
,.,
,., 4' .7
,.o
'.o
,., ,.o
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5
5.7
'77 .5'2
,.,
,.2
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S.J
.s.2 23.1
5.5
-2.
''5.275
,.,
,.,
,.2
1.8
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J.1
4.7
2.8
).I
3
.0
JO.!'
1,.2
,.,
,.,
18.4
10.2
-0.1
1.0
5.0
I.I
3
1.8
,.o
From mid-1978 to mid-1979, the second half of this year and ir. the opening
quarters of next year, the economy is likely to show only moderate growth,
averaging about 31'2%. Interest rote increases hove diminished inflows into savings
institutions by 35%, which will gradually affect housing activity, bringing starts
down by 20% from their peaks. Consumer outlays are held back by an abovenormal debt burden. Inventories showed surprising strength in the first quarter,
leaving little room for further increases. By mid-1979, the economy will be ready
for another acceleration, and 1980 should be quite a good year.
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,.,
2.,
2 .o
J.l
6
The inf lotion rote reached 7% in the first quarter, renewing fears of acceleration.
However, the data must be seen in the perspective of last year 1s pattern. During
the second half, the GNP deflater rose by an average of only 5.3%, aided by a
decline in agricultural prices. These price declines could not be expected to be
permanent, so it is not surprising that form prices have led the current inflation
bulge. The GNP deflater is up 6.2% over the past four quarters; the CPI is up 6.4%
in the twelve months ending in February and the WPI is up 6.5% in the twelve
month ending in Morch. These ore better indicators of the inflation picture.
There is no reason to look either for on escape from the hard-core inflation rate qr
for a major acceleration. Cost inflation continues: expectations which form the
basis of wage claims are built on the hard-core inflation rote, and so wage
increases will persist between 7% and 8%. Total compensation, including fringe
benefits and payroll taxes, will be up by over 8%. Energy prices will help produce a
cost trend near 6"2%. The case against accelerating inflation is also clear: physical
capacity and labor ore in ample supply at home and abrocd. There is substantially
more slack outside the United States with the growth prospects in both West
Germany and Japon continuing abnormally low. The world-wide glut of industrial
capacity limits the dangers of demand inflation. The cost factors alone will not
produce a significantly accelerating inflation, just persistence of the hard-core
rote.
THE FORECAST COMPARED TO ADMINISTRA TJON GOALS
The DR! forecast calls for an average growth rate of 4.2% for the years 1978 to
1980. The Administration goals are somewhat more ambitious (Table 2), and are
way-stations on the poth to the more ambitious goals of the Humphrey-Hawkins
Act. But if the path of the DR! forecast were actually achie~ed, the record of
economic performance would be considered a good one by most observers, and
would represent a big improvement over the situation of the mid-1970s.
TABLE 2 - President's Goals 1 end ORI Forecast, 1977-80
I
Real Growth
Inflation
Unemployment
Goals
Forecast
4'2 % to 5%
-'2% a year
4.2%
no change
-V,% a year
-0.3% a year
1Economic Report of the President, pp. 5, 19, 154-6.
Recent developments show great progress on the unemployment targets, but
setbacks on the inflation front. Furthermore, the international problem has
reoched pressing proportions. In this circumstance, great caution must be applied
A quick dash toward exponsion, os
in pursuing the Administration goals.
exemplified by easy budget policies and easy money policies, will not hasten the
accomplishment of the goals but will simply accentuate the cyclical character of
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Federal Reserve Bank of St. Louis
7
the economy. History amply demonstrates that once the economy reaches a boom
condition, it is beyond the ability of policy to control events. Recession follows,
with its large increases in unemployment and the long deferral of the reaching of
full employment goals.
The economy is not in a boom condition, and under the DR! forecast would ovoid it
between now and 1980. Chart I shows the DR! composite Boom Monitor Index, a
collection of indicators which hos identified previous periods of boom. There is on
excellent prospect of achieving several more years of solid expansion if policy
extremes are avoided.
THE MIX OF FISCAL Al'O Mor-ETARY POLICIES
At-0 Tt--E TAX CUTS
The I 5179 budget is too expansionary. The full employment budget deficit was
proposed to deepen in 1979, after having already expanded in 1978. A policy of
expanding full employment deficits in years four and five of on economic expansion
must be interpreted as highly stimulative and ca, be rationalized only on the
assumption that the economy is inherently extraordinarily weok. There is ample
evidence that the economy is doing pretty well on its own.
Tobie 3 shows DRl's current estimates of the full-employment budget deficits for
the years 1975 to 1980. The policy assumptions include retention of the social
security tax increases, passage of the wellhead tax as in the current House bill, and
the President's $25 billion tax cut proposal on October I. It can be seen that the
full-employment budget deficit shrank from $14 to $9 billion in 1977, before the
initial Carter stimulus program become effective. In the current fiscal year, the
deficit widens to $16 billion, and for 1979 it would surge to a dangerous $26 billion
figure. Sy 1980, the deficit would shrink once more as the second stage of the
wellhead tax becomes effective.
CHART I - DR/ Boom Monitor
,0.--.........-.------,..-.,,--~,~-~
TABLE 3 - Full-Employment Budget Deficits,
1975-1980,
(NIA Basis, Billions of Dollars)
BO
Fiscal Years
(October-September)
,o-
1975
1976
1977
1978
1979
1980
50
•o
30
2t)
10
1'45
155D
1555
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Federal Reserve Bank of St. Louis
156D
196'5
197D
197'5
-/4.0
-13.9
-8. 7
-16.3
-26.5
-12.8
8
What would be a prudent budget policy, to be combined with a moderate monetary
policy, to enhance the prospects for continued orderly expansion? Post experience
has shown that it is impossible to devise a fiscal policy that will precisely correct
the short-run fluctuations in the private economy.
In the current circumstance,
where the economy is moving well and inflation is worrisome, a policy of gradual
reduction of the full-employment budget deficit recommends itself.
_The current $16 billion full-employment budget deficit could be wiped out over a 5year time span. This would imply a full-employment budget deficit of less than $14
billion in fiscal 1979, and of about $10 billion in 1980. Comparing these goals to
the current prospects, a deficit reduction of about $12 bi Ilion is necessary for fiscal
1979, and of about $2 billion in fiscal 1980.
Postponement of the tax cuts until January I, 1979 would reduce the budget deficit
by obout $6 billion, leaving another $6 billion of reduction to be found. A scaling
back of the net tax reduction from $25 to about $20 billion would put the budget on
the recommended path to balance on the full-employment basis by 1983.
TABLE 4 - Effect of 3-Month Postponement of Tax Cuts
Real GNP (% Diff.)
Consumption (Real, % Diff.)
Housing Starts (Thousands)
Business Fixed Investment (Real,
% Diff.)
Inflation Rate (% Diff.)
Unemployment Rate {% Oiff.)
Budget Deficit, NIA, (Diff.
in Bil. $)
Fed Funds Rate (% Diff.)
Fourth Qtr.
1978
Year
1979
Year
1980
-0.3
-0.4
-16 .o
-0.2
-0.3
0
0
-0.1
+7.0
-0.2
-0.4
-0.1
0.1
-0.2
-0. I
-21 .3
- .04
-0.3
-.13
0.2
-. 10
..
.
*Less than • I
The effects of the postponement are very small, about 2/ 10 of a percent on real
1979 GNP, concentrated in consumption, which gradually brings a near equal
improvement of inflation. This makes no allowance for the benefit of avoiding the
confusion created by tax changes effective during a taxable year, including the
changes in 1978 withholding schedules and the uncertainties of the April 15, l 979
settlement payments.
The effects of postponement plus the modest scaling-back of the cuts are also quite
moderate. Real GNP is off 0.4% for 1979 and inflation improves by 0.2% in 1980,
The smaller budget deficits help
financial conditions. Unemployment is up by a tenth of a point. The policy change
would allow monetary policy to be a little more generous, though this is not
assumed in the simulation.
and slightly more in the succeeding few years.
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Federal Reserve Bank of St. Louis
9
TABLE 5. - Effect of Postponement Plus $5 Billion Cut
in Personal Tox Reduction for 1979 and $2 Billion Cut for 1980
Real GNP (% Diff.)
Consumption (Real % Dill.)
Housing Storts (Thousands)
Business Fixed Investment (Real,
% Dill.)
Inflation Rate ( % )
Unemployment Rote (% Diff.)
Budget Deficit, NIA
Fed Funds Rote (%)
Fourth Qtr.
1978
Year
1979
Year
1980
-0.3
-0 .4
-16.0
-0.4
-0.5
-5.0
-0. I
-0.2
10.0
-0.2
0
0
-21.3
-.04
-0.5
-0.1
0.1
-4.4
-.19
-0.4
-0.2
0.1
-0.8
- .20
.,
A PROBABILISTIC ANALYSIS OF THE MONET ARY TARGETS
ANO THEIR RELATION TO ECONOMIC PERFORMANCE
According to the DR! forecast, the narrow money supply (Ml) will increase by 5.8%
between the first quarter of 1978 and the first quarter of 1979, comfortably within
the most recent target range. Higher interest rates and a slower economy are
likely to produce this modest MI growth.
This result assumes an increase of
nonborrowed reserves provided to the banking system through open market
operations (or changed reserve requirements) of 5%4 The F ederaJ funds rate
averages 7-1/4% in the second quarter, stays over 7% in the third quarter, and
fades ofter the economy hos clearly embarked upon its period of moderate growth.
The brood money supply (M2) rises by 9% over the some interval, at the upper limit
of the most recent F ederol Reserve long-term targets. M3 is forecast to grow by
9.9%, also near the upper end of lost quarter's targets.
These single-point estimates produced by the large-scale DRl econometric model
ore helpful in showing the overage relationships between policy, the economy, and
the growth of the various measures of money under the assumptions of the
forecast. These estimates ore port of the general forecasting work of ORI, and a
good deal of effort, data, and computer resources has gone into them. They ore our
best judgment estimates and we stand solidly behind them.
However, the economy contains much that is unpredictable. The model equations
did not explain the past perfectly, but included observed errors. Policies ore not
predictable, and there are other exogenous influences, including the world price of
oil, the availability of world crops, and the behavior of foreign economies
generally, about which assumptions must be mode which ore subject to error.
As a result of these unknowables, single-point calculations must be combined with
risk analysis to determine the range of uncertainty to assess the resultant
uncertainties for the economy. For the purpose of these hearings, ORI hos applied
its recently developed stochastic simulation facility to the question of one-year
monetary growth. The results are instructive.
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Federal Reserve Bank of St. Louis
10
What was done was this: for each of 350 equations, an error term was entered for
each of the next four auarters. These terms were drawn from distributions which
ore normal, with a staidard deviation equal to the standard error of estimate of eoch
equa1ion, but also embodying the persistence of errors through serial correlation
and the; coincidence of errors across equations as reflected in the covariance
matrix.
Error terms for about I00 policy and other exogenous variables were
defined by assuming variations around trend values distributed as in history. The
set of error terms was entered in a simulat1on of the full model, and this process
was repeated 100 times in order to generate a distribution of simvlotion solutions
for all the variables. This procedure has approximated our actual ability to
forecast; that is, the variables with small distributions in the experiment are also
the variables which have been forecast wit~ relatively small errors and vice-versa.
Table 6 summarizes the experiment, using the forecast solution os the base line.
Chart 2 displays the distributions for Ml.
CHART 2 - Distribution of Outcomes for Money Svpply Growth
(Ml), 100 Simulations, 1978:1 to 1979:1
"'
Number
of
Simulations
5,5
6
6.5
7 7.5
Ml Growth
1Two early papers applying stochastic simulations to macro models ore: J.S.
Duesenberry, 0. Eckstein, and G. Fromm, 11 A Simulation of the U.S. Economy in
Recession,1 1 Econometrica, and 1. Adelman and F .L. Adelman, "The Dynamic
Properties of the Klem-Goldberger Mode!,n Econometrica, October 1959, pp. 596625. The present study generally follows the tecnnique developed by M.D.
McCarthy, in "Appendix," to "Prediction and Simulation of the Wharton Model," in
Econometric Models of Cyclical Behavior, B. Hickman, editor, pp. 185-191, but
adding shocks to the exogenous variables. See Joe Kelley, "Forecast Risk-A
Stochastic Simulation Analysis," Data Resources Review, November 1977, pp. 1730, for a full account of the ORI rneTFi'"od and in1t1al results.
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Federal Reserve Bank of St. Louis
11
The range of growth of Ml stretches from 7 .5% to 4.2%, taking the extreme
simulation answers as determining.
Ninety percent of the solutions produced MI
growth between 4.8% and 7. I%; 50% of the solutions falls between 5.3% and 6.4%.
Twenty-three percent of the solutions showed MI growth above the upper end of
the target range; 5% exceeded 7%. Table 6 shows the comparable figures for M2
and M3, and the distributions for various other important variables. Table 7 shows
the probabilities of the monetary aggregates staying within the lost set of target
ranges.
TABLE 6 - Risk Ranges from the Stochastic Simulation
Crowth Rotu !978:
J
To
197,: !
(Unfes.1 Otherwise lndicoted)
Stoc:host ic Sirrulat ion
?er cent i I es
High
95%
75%
50%
25~
S'!fi
L.ow
7.4
6.S'
&.7
,.,
5.4
5 .o
i.9
4.4
4. 2
3.5'
3. 3
3. I
2.6
2 ,4
10.5
10.0
8 I
6.6
IS.I
lf.6
17.Q
7.0
16.!
5.3
4.5
12.0
I .9
-0. 2
10.8
-0.2
5.4
4.7
5.1
2.7
4.7
7,4
6.7
7. i
6.7
1.:
6.3
7 .0
6.4
7.0
:LI
,LS
Reo I G. N, P.
C::ins~r,on
..
F'ixed lnvest~enr
aus iness .
Res1den1 ,al
ex0or ts
lmcor ts
..... .
Government Spena,ng
State & Local
Federal
,.,
,.J
6.2
7
.o
5. 2
2 7
0.9
• .:..2 -!1.8 -14.1
a. J
2."
.J, 3 -o.s -8.9
I.]
4. I
•0.9
3 5
•J.2
6.7
5.8
5. I
5.4
6.5
5.5
4 .8
5.0
Wages and ?rices
.:..vg. i-1ourl)' 2ar'l1ngs
G. N. P. Oefloior
'Nhol eso le ?r; ces
Consi.rr,er ?rices
7.9
7.1
9 .4
.
7.8
7.7
7.0
3 .8
7.3
5.?
lrice,,,es
?~rsonol lnc::me
.
~ea I O, s;,. lnccrre
12. I
7.2
! 1.6
6.2
10.5
5.1
4.5
J.8
Corporal~ ::irof,
Before Tax
After Tax
26.8
31.J
23.6
H.1
f,i.7
23.1
:3.7
IS'.0
9.5
15,5
7.5
7.!
9. 7
13.7
10.5
20.J
8 .s
6.4
5',2
11.2
8.2
]. l
!I.,]
9.1
2.i
0.3
i.5
Dther
,\o\one:, Suopl y
...-O.EY2
vO-EYJ .
10. 0
. ..
!4.7
lr1ous:, P·oauct,on
12.2
26.4
14.4
rlous 1ng Sror rs
Car Sh i;:,rr,enrs
Sr,:it
I
,_,
7.8
5.1
5.9
8.3
5.3
3.2
a ...
'J.7
6 . .i
).0
I. i
5.1
-1.7
-0.8
4.8
7.7
o.7
4.2
i.!
s.1
0.0
-a.9 -20. 1
-4.8 -8. I
2 .9
onary Ser, es:
Average '.or l::'7a:2 to 1?77:1
(?ercentcges 2xce~t ~o, =-ec:er-::il Sur:>l•Jsl
1~·netr.0
loyrre:it Rote
Feo
Sur::, 1 JS
(6i I I.$)
l,1teres1 ~at;?s
Feaero I =·,ncs
.
?• .me 3us. Loo:is . .
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Federal Reserve Bank of St. Louis
r'-lew Cor?Orote 3onds
l>.8
6.5
5.2
6.1
-32. 7 .:..J .5 .49. 9 -53.:S
9. 02
9. ~4
9. 29
7. 87
". oo
Q. I 3
7 . JO
7 . 07
3.9$
3.83
a. 3 s a. os
5
-sa
~. 6 l
7.: a
3. i.
5.7
5
.,;2 .6 --:i7
i,. 20
~ . ,.9
3.55
5. 7 4
5. a0
9 .43
12
The range of outcomes for real GNP growth is even wider, stretching from as low
as 2..6% in the worst solution to as high as 7 .4% in the most favorable. This range
probably exaggerates the range of uncertainty. If the economy really entered upon
one of the extreme paths, policy would take countering moves. On the monetary
side, the day-to-day operationCII target is the Federal funds rate, and it, in turn, is
affected by the achievement of the two-month money targets. Thus, there is a
loop from results back to policy that would narrow the range of outcomes beyond
the figures in Table 6, at least assuming that these short-term policy loops are
stabilizing rather than destabilizing.
TABLE 7 - Probabilities For Growth of Monetary Aggregates
1978: I to 1979: I, Classified According to the 7::<'rget Range
Ml
M2
M3
Lost Target Range (77:4 to 78:4)
4-6\',
6Y,-9
7\'z-10
Greater Than Target
.23
• 77
0
.29
.69
0
.45
.43
.12
Within Range
Below Target
The lesson from this initial set of exercises is clear: the range of ovtcomes for the
monetary targets, in the octuol economy, is large. To set the monetary targets is
not to set the future poth of the economy. Setting the targets for nonborrowed
bank reserves does not determine the range of outcomes for the monetary
aggregates because the demand for money is itself o result of the behavior of the
economy. Clearly, the one-year monetary targets are not a sufficient guide to
monetary policy.
l argued earlier in my testimony that the path of the economy embodied in the ORI
forecast foils somewhat short of Administration goals, but would still represent a
handsome accomplishment in terms of economic performance. That path, in the
forecast solution, is consistent with a 5.8% increase in MI, and thus on the singlepoint basis, an MI target of 6.5% appears to be adequate. However, the stochastic
simulations make it clear that there is one chance in four that the actual MI
growth will exceed 6.5%. Thus, if the economic scenario itself is considered
acceptable and policy proves sufficient to accomplish it, when you meet one year
from now the chances are one-in-four that the Chairman of the Federal Reserve
will be apologizing for the continued overrun of MI above the upper end of the
range.
Is there any meaning to the lower end of the lost target range? A simulation was
developed which cut nonborrowed reserve growth to the point that held MI growth
to 4%. The result is recession. The Federal funds rate reaches double-digit levels,
which would produce a futl-scole credit crunch and recession. The stochastic
experiment run on this base produced few good answers out of the I00 runs.
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Federal Reserve Bank of St. Louis
13
THE CURRENT FINANCIAL CONDITIONS AND THE
RISKS OF A CREDIT CRUNCH
The Federal funds target was raised ta 7% !ast week, and according to the ORI
forecast, a move to 7-1/4% is due quite soon. Ml will respond to the high GNP
growth, moving out of the target range. Chairman Miller has indicated that his
contributions to the fight against inflation is just beginning.
The critical question for monetary policy--ond therefore for the economy-is this:
how high can interest rotes go before they unloose a cumulative disturbance in the
financial system? !n considering this question, it should be recalled that there is
not a single instance of success in raising interest rates to moderate the economy
without creating a major disturbance. The Federal Reserve hos carried the policy
too far every single time.
Despite the 35% decline in savings flows and the increased volume of bank loans,
the financial system is still in good condition and able to finance further expansion.
OR!'s Credit Crunch Monitor is giving just a few warning signals, no more. Business
and household balance sheets ore strong, and financial institutions are cautious.
The only emerging trouble spot is the falling supply of mortgage money, which is
port of the forecast. The stochastic simulations show the limits of our knowledge,
however. It takes very little to combine bad luck with policy to produce a cyclical
disturbance.
The danger lies in Federal Reserve overenthusiasm. The Federal funds rate cannot
be raised again and again and again. With every move from here on, the risk of
disintermediotion and a credit crunch mounts. When government-including the
central bank--gets excited about only one objective, whether unemployment or
inflation, it usually overreacts. Let1s hope the people in authority have learned
that lesson from the experience of the lost twenty-five years.
CONCLUSION
Retention of the current monetary targets is the appropriate policy. To raise the
targets wou(d signal a lessene<:I concern with inflation and the exchange rate. To
lower the targets ...vou!d either raise the risks that they will be exceeded by actual
experience, or that policy will create a credit crunch.
There is one chance in four that the targets will be exceeded. Our stochastic
simulations indicate the range of 1.mcertointy about the monetary targets end the
economy. We should not be surprised if this contingency develops. On the other
hand, with current interest rate levels and the prospects for moderate economic
growth, there is a better chance for staying within the targets than there has been
in quite a few years.
There is roam for modest interest rate increases from current levels. But the
margin for error is becoming small. If the current interest rate move is the first of
an extended series, we wH I rep(ay history once more, and plunge the economy into
a credit crunch and recession.
28-083 0 • 78 • 2
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Federal Reserve Bank of St. Louis
14
To hold monetary policy near the center of the spectrum, fiscal policy should do its
port. The full-employment budget should be on a path toward balance, which
requires a scaling back of the proposed tax reductions or tougher spending policies.
With centrist monetary and fiscal policies, the economy hos en excellent prospect
of achieving several further years of good growth without accelerating inflation.
These hearings play an important role to help bring about this result by focussing on
monetary policy. Let us hope that other committees and the Congress will help
achieve the fiscal policy and the improvements in various structural policies that
will make achievement of our economic goals possible.
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Federal Reserve Bank of St. Louis
15
The CHAIRMAN. Thank you very much, Dr. Eckstein. Dr. Santow.
STATEMENT OF LEONARD SANTOW, ADVISER TO THE BOARD AND
SENIOR VICE PRESIDEN'X, 1. HENRY SCHRODER BANK AND
TRUST CO., NEW YORK
Dr. SANTOW. I have a few remarks to make which were not part of
my official statement because I wrote the statement on Monday and
Tuesday and the Federal Reserve tightened policy on Wednesday.
These remarks will center on what happened and why it happened.
Analysts in the money market generally did not expect a tightening of the Federal Reserve policy at the April open market meeting.
I think there was a feeling among most analysts that the Federal
Reserve would wait for a second month of numbers on such things
as the money supply, industrial production, personal income, housing
starts, before they moved; 1 month's numbers would not be sufficient.
Thus, the tightening was a surprise at least in terms of timing.
In my judgment it would be very difficult to justify the recent
tightening on the basis of the international side where the dollar at
least in the last few weeks has done better and where tightening of
money rates doesn't really help the United States a great deal since
we generally have higher short-term rates than other countries.
As for some other considerations, the money supply showed a
minus growth in February, a small plus in March, a fairly decent
size plus in April, and then will probably move to a slower rate of
advance in May. In my judgment, there was not enough evidence to
firm policy on the basis of these numbers.
I believe there were two basic reasons for the firming. First, I
think the Federal Reserve used the change as a signpost-call it a
warning, if you will-that they are concerned about inflation and
that they want more help from the administration and from Congress
in that area. They can get that message across with one-quarter of
1 percent increase in the funds rate just as easily as they can with
a large increase.
Second, and possibly the more important reason, is the aspect of
credibility. When the Chairman and other senior Federal Reserve
people make numerous statements about what they are going to do if
other people do not act, they cannot maintain creditability unless
they put something behind those statements. This is especially important for a new Chairman who is attempting to indicate both his
capabilities and his leadership.
I will now turn to my formal statement which is rather short but
I think to the point.
[Complete statement follows:]
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Federal Reserve Bank of St. Louis
16
AN ANALYSIS OF OFFICIAL POLICY
by
Dr, Leonard J. Santow
Senior Vice President and Advisor to the Board
J. Henry Schroder Bank & Trust Co,
Presented before the Senate Banking Conmittee
Washington, D. C.
April 24, 1978
A.
Introductory Remarks
1.
Monetary and fiscal policies should be viewed as a package,
not as separate entities.
This approach should be used by
both the Administration and by Congress when judging policy.
-'l'wo basic questions need to be asked.
First, does the combination
of monetary and fiscal policies give the proper amount of restraint
and accomodation and second, is the balance between monetary and
fiscal policies an appropriate one?
At the present time, while
the overall posture of the two policies may be relatively reasonable,
the balance between the two is totally inappropriate,
The budget
deficit is far too large for this point of the business cycle,
and the deficit is likely to become larger, while monetary policy
in terms of interest rates is too restrictive since it is courting
disintermediation.
Thus, while the private sector of the domestic
economy has few imbalances or excesses that could create a recession,
the public sector has major imbalances.
A huge budget deficit
not only saps the creditability of an Administration and Congress,
but it also creates upward pressure on interest rates at a time
when the Federal Reserve may feel compelled to firm policy because
of inflation and money supply problems.
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Federal Reserve Bank of St. Louis
17
2.
An incomes policy, even if it is well conceived, is not a substitute
for appropriate monetary and fiscal policies.
If it is to be
successful, an incomes policy can act only as a complement to
monetary and fiscal policies, or it can buy some time in order
to get one's monetary and fiscal policies in order.
An incomes
policy does not attack the causes of inflation, it only moderates
the-effects.
Moreover, there is a momentum to an incomes policy
towards an even greater amount of Government intervention as loopholes
are dosed or voluntary policies are
reinforced.
This in turn leads
many to believe that wage and price controls are the likely result
which in turn induces the private sector to obtain wage and price
increases before controls limit such advances.
'This situation,
of course, adds to near~tenn inflation and puts more pressure
on the Government to impose controls.
B.
Fiscal Policy
1.
The budget deficit in the current fiscal year will be between
$50 billion and $55 billion; in the next fiscal year (1978-79),
it is likely to be between $65 billion and $70 billion; and if
no major steps are taken, ,in fiscal 1979-80 it could approach
$75 billion or $80 billion.
The main reason for the deterioration
in the 1978-79 budget is that the proposed tax reductions will not
generate enough economic stimulation to offset the revenues lost
from the tax reduction.
A $22 billion tax reduction in a $2 trillion
economy that is losing momentum will do little to maintain the
recovery while the loss of considerable tax revenues will have
a substantial adv~rse impact on the size of the budget deficit,
on interest rates, and on the ucrowding" problem in the credit markets.
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Federal Reserve Bank of St. Louis
18
'tll.e ireriod of main near term credit market concern should be from
October 1978 to March 1979 when interest rates are likely to
reach their peak for this business cycle.
2.
The large budget deficit at this late point in the business cycle
substantially hinders fiscal policy flexibility.
After three
years of a business recovery, the proper status of the budget
is to be near balance.
Because of the large size of the deficit,
Congress is no doubt inhibited (and correctly so) as to how much
it can affort to stimulate the economy even if it appeared that
business was slipping into a recession.
Then, should there
be a recession in 1979 or 1980, the huge deficit would no doubt
limit what Congress would do to stimulate an economic recovery.
C.
Monetary Policy
1.
Monetary policy is likely to be dominated principally by domestic
considerations since raising interest rates will not get at the
basic dollar problems.
Moreover, raising interest rates by
a considerable amount will do more harm to the domestic economy
than help the U.S. international situation.
2.
The Federal Reserve will probably firm policy over the next several
quarters, but more reluctantly and by smaller amounts than last
year.
In 1977, the Federal Reserve provided impetus to higher
short-term rates, while this year the monetary authorities are
likely to be a rather reluctant follower of credit market pressures.
Financing problems, mainly from the Treasury, will be the primary
force moving interest rates higher.
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Federal Reserve Bank of St. Louis
19
3.
The Federal Reserve's flexibility at a 6 3/4% Federal funds rate
is far more limited than it was in early 1977 when the rate was
2% less.
Another 1/4% or 1/2% increase in the Federal funds rate
and there could be noticeable changes in both the direction as
well as the magnitude of savings flows.
4.
The Open Market Comnittee will not speak with one voice as it
did last year.
Moreover, the Board staff will have greater
influence and power.
moves
5.
This probably means smaller and less frequent
by the Federal Reserve in changing policy.
The money supply (M-1) growth for calendar 1978 is likely to
average between 6% and 7%.
Since the rate for the first quarter
was about 4%, one can expect a notably higher average in the last
three quarters of the year.
The second quarter will probably
show an especially rapid rate of advance as the economy recovers
from the first-quarter doldrums.
With nominal GNP likely to rise
about 11% this year (4% real growth and 7% price), a 6% to 7% rate of
advance in the money supply would not be surprising.
6.
The monetary authority will probably place less emphasis on M-1
compared with last year, although it will still probably be the
single most important consideration.
The Open Market Committee
will probably place more emphasis this year on a combination
of factors -- inflation, unemployment, industrial production,
and the U.S. international position.
Therefore, it will be harder
to predict in advance when and by how much the Federal Reserve
is likely to change policy.
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Federal Reserve Bank of St. Louis
20
7.
The Federal funds rate, which is currently at 6 3/4%, is likely
to move up to 7 1/2% by the end of the year.
These disintermediation
levels will create considerable pressure to raise the current
Regulation Q ceilings.
The rate levels in the Government market
that will trigger substantial disintermediation are 7% on threemonth Treasury bills and 8% on two-year notes.
8.
In sunmary, Federal Reserve policy will be walking a tightrope
because the Federal funds rate in
my
judgment will probably move
to levels higher than it should but the money supply will probably
be growing 1% or 21. more rapidly than it should.
Thus, the monetary
authority will not be accommodative enough from an interest rate
viewpoint but too aeeommodativefrom a money supply standpoint.
A major part of this dilemma is due to an excessively large Federal
budget deficit with all its adverse ramifications.
D.
Recotrmendations
l.
Every year the Administration in its Budget message and Congress
in its budget committees should set targets for a package of four
variables, making sure that each target is consistent with the
other three
the size of the budget deficit, the maximum percentage
increase to be allowed in Government spending, the path and level
of Federal funds rates and the growth in the money supply.
In order to attain creditability, these targets should have
a reasonable possibility of achievement.
For example, in the
case at hand, an 8% ceiling on Federal spending growth, a $50 billion
budget deficit for the current calendar year, a Federal funds rate
basically unchanged from the 6 3/4% level, and a growth of about
5% in M-1 would be reasonable
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Federal Reserve Bank of St. Louis
for 1978.
Then in the following
21
year, a smaller 6% growth ceiling on Federal spending, a smaller
$40 billion budget deficit, a lower 6% Federal funds rate and
a smaller growth in M•l of about 4% would be approximately targets.
2.
In order to hold down the budget deficit to $50 billion this year
and then bring it down to $40 billion next year, not only would
we need an 8% growth ceiling on spending this year and a 6%
ceiling next year, but we would also need virtually no loss
in revenues from a tax reduction.
What can be done is to pass
a tax reduction that does not become effective until sometime
in 1979, and then have small yearly reductions spread over
a period of five years.
For example, the reductions could
be $8 billion to $10 billion each year for five years.
While
it currently may not be of great cash flow help to businesses
and individuals, such a tax reduction would allow both to make
longer run plans with more assurance.
3.
An argument that will be made against these proposals is that
they would risk a recession in either 1979 or 1980 because it
is highly unlikely that fiscal-monetary policy coordination
and the fine tuning would work that well.
It will also be
argued that even if such a program were accepted, it would
take a year or two to put in place,
are valid.
Both of these arguments
However, it should be pointed out that the risk of
a recession in 1979 or 1980 is already substantial since the
Federal Reserve is likely to tighten more than it should in
order to compensate for excessive increases in Government
spending and an overly large budget deficit.
The important
difference between the two alternatives is that when we try
to come out of a 1979 or 1980 recession it will be much easier
to do so if these imbalances in public policy have been rectified.
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Federal Reserve Bank of St. Louis
22
E.
Enclosures
1.
On the next page, budget estimates are broken out in some detail.
This presentation will allow Committee members to monitor budget
numbers as they come out each month.
2,
On the following page, the monthly growth in the money supply
and changes in the Federal funds rate are presented.
This
allows Committee members to look at monetary policy in the last
year, both in terms of monetary aggregates and interest rates.
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Federal Reserve Bank of St. Louis
23
BUDGET ESTIMATES
(billions of dollars)
~
1976-77
1977-78
DEFICIT OR
SURPLUS
EXPENDITURES
1976-77
1977-78
1978-79
1976-77
1977-78
1978-79
October
21,0
24. 1
1978-79
27 .o
34.0
38.8
42,0
-13.0
-14. 6
-15.0
November
25. 7
27 .6
31,0
33.1
36.9
41.0
-
-
-10,0
7 .4
9.3
December
29. 5
32. 8
36,0
31, 9
37 .6
41.0
- 2.4
- 4. 9
- 5, 0
January
30.0
33. 2
36,0
32,6
36. 9
40.0
-
- 4.0
February
24. 3
26 ,8
29.0
30.9
33.8
38,0
- 6.6
- 3. 7
- 7 .o
2, 7
- 9,0
March
25 .1
28.0
30,0
34.6
38.0
41.0
- 9.5
-10.0
-11.0
April
40.0
45.0
48.0
35 .5
38.0
42.0
+ 4.4
+ 7.0
+ 6.0
May
27. 7
31.0
33.0
33. 7
38.0
42.0
- 6 .o
- 7 .o
- 9. 0
June
43 .1
49.0
52.0
32. 9
38.0
42 .o
+10.2
+11.0
+10.0
July
25 .o
28.0
30.0
33.6
38.0
42.0
-10.0
-12.0
August
29. 7
33 .o
35. 0
34. 7
39.0
43.0
- 8. 7
- 5 .a
6.0
- 8.0
~
_£,.Q
45.0
..12.:.1.
40.0
44.0
+ 1.5
+ 2.0
+ 1.0
356. 9
400.5
432. O*
401. 9
453.0
498.0
-45.0
-52 .5
-66.0
September
(439. 6)
(500. 2)
Assuming a $22 billion tax reduction, with most of it effective
Official numbers.
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Federal Reserve Bank of St. Louis
-
(-60. 2)
1/1/79.
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Federal Reserve Bank of St. Louis
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25
The CHAIRMAN. Thank you, Dr. Santow. I want to thank both you
gentlemen for very thoughtful and impressive statements. I say that
because I agree with some of them.
Dr. Eckstein, given your economic forecast for the next year or so,
how would you judge the Federal Reserve's current decision to let
the Federal funds rate rise to 7 percent at this time?
Dr. ECKSTEIN. Well, it came very quickly. If you accept a budget
policy, if you take that for iranted, then the increase in interest rates
is not a totally inappropriate response to the worsening inflation
in the recent months or of the really dangerous situation in international trade. The Federal Reserve cannot sit there and ignore
what is happening to our trade deficit and what is happening to the
actual price performance. So I'm not critical of the move that was
made last week.
The CHAIRMAN. What you said, however, as I followed you, was
that we are in a position now where that kind of interest rate activity
is unlikely to have much effect on inflation in view of the enormous
amount of unused capacity we have and particularly foreign countries have. We are not at this kind of a stage in the cycle, although
we have been recovering for a long, long time, where we are pressing
against capacity, either manpower capacity or fa.ctory capacity.
So what good does it do to slow things down? The Wall Street
Journal reported this morning that there's going to be consifterable
pain in corporate board rooms as interest rates are expected to rise.
What good does that do now? How does that slow down inflation?
Dr. ECKSTEIN. Well, any single eighth of a point interest rate is
only an eighth of a point interest rate move, and my concern is really
with the now widely held viewpoint in the business community that
the rates will go up and up and up until there is a recession and an
even worse feeling from some people that they welcome that.
The impact of monetary policy on inflation is very, very slow. It
takes 2 or 3 or 4 years before that tighter monetary condition can
itself effect more moderate inflation. The benefit is initially on the
output side. The cost comes much later. So the current situation is
not unsatisfactory from my point of view.
The CHAIRMAN. Well, what effect is it likely to have on the economy
during the last half of the year in your view, if any~
Dr. ECKSTEIN. Well, the interest rate increases of last year which
of course were much more massive, as the chart in the room here
shows-The CHAIRMAN. And that adds to it. That's one of the reasons we
put these charts up. The Federal funds rate, as you noticed, has been
going up steadily. This is the latest push in it.
Dr. EcKSTEIN. The Federal funds rate went up 200 basis points.
The bond yields have gone up over 100 basis points and, as a result
of that, we are forecasting a substantial slowdown in the growth rate
to about 3½ percent from mid-1978 to mid-1979.
This means that during this period the economy will not improve;
unemployment significantly might even worsen a little bit; but that's
water over the dam and that really in a sense is also the old team.
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Federal Reserve Bank of St. Louis
26
The CHAIRMAN. Let me ask you, Dr. Santow, what effect, in your
judgment, will the 7 percent Federal funds rate have on the money
and credit markets and is the move appropriate at this time in your
view?
Dr. SANTow. As I said before, I would not have firmed monetary
policy at this point. I would have waited at least another month for
substantiating data and therefore believe the change was used to
develop credibility, given all of the Federal Reserve statements made
in the last month or so. A trend towards a firmer monetary policy,
which incidentally is in my economic forecast, will be a factor leading to only a 2- to 3-percent real growth rate in GNP for calendar
1979.
The CHAIRMAN. Dr. Eckstein, what's your estimate of the lag between interest rate changes and the changes in the money stock? You
said there was a long lag in changes in the money stock and the
changes in the economic activity. First, between interest rate changes
and then changes in the money stock-how long is that?
Dr. ECKSTEIN. It's a gradual process. It can take as long as a year
and a half before the full effect is felt on the money supply.
The CHAIRMAN. What is the first effect? You say the full effect.
Dr. ECKSTEIN. There is little effect right away, of course.
The CHAIRMAN. Then you say it's a gradual effect over a period of
a year or year and a half?
Dr. ECKSTEIN. You see some effect in a month or two. You probably have a peak effect in 6 months or 1 year. The process is pretty
much complete a year and a half later.
The CHAIRMAN. How about changes in the money stock and economic activity?
Dr. ECKSTEIN. The effect of the entire package of credit costs and
availability on real activity is very quick. Some occurs within a
Quarter or two. Then it mounts for some additional period, as much
as a year and a half, but the effect on prices comes 2 or 3 or 4 years
later.
The CHAIRMAN. Now I'd like for each of you gentlemen to give me
your personal forecast for real GNP, unemployment, and inflation
for the next year, the first quarter of 1978 to the first quarter of
1979. First, real GNP, Dr. Eckstein.
Dr. EcKSTEIN. Well, all that material is in my table 1 for the year
1978, our real GNP rose 4 percent and the growth rate at the beginning of 1979 is 3.1 percent.
The CHAIRMAN. All right. Dr. Santow.
Dr. SANTOW. By the first quarter of 1979 the U.S. economy will be
running at about a 3-percent real rate of growth.
The CHAIRMAN. All right. Unemployment by the end of 1979, Dr.
Eckstein?
Dr. ECKSTEIN. We look for an unemployment rate at the end of
1979 of 5.9 percent.
Dr. SANTow. Let me ask you, on the real growth, did you want the
first quarter of 1979 or the last?
The CHAIRMAN. First quarter of 1978 to the first quarter of 1979.
Dr. SANTOW. Okay.
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27
Dr. ECKSTEIN. Let me correct the record. I thought the question
was during that quarter. Our growth average for the four quarters
covered by this hearing is about 4.9 percent.
The CHAIRMAN. That's the first quarter of 1978 to 1979 is 4.9 percent?
Dr. ECKSTEIN. Yes.
Dr. SANTOW. I'd say 3 percent to 3½ percent.
The CHAIRMAN. Now unemployment by the end of 1979 Dr. Eckstein has given us. Dr. Santow?
Dr. SANTow. About 6½ percent.
The CHAIRMAN. Inflation, Dr. Eckstein, first quarter of 1978 to the
first quarter of 1979 ?
Dr. ECKSTEIN. On the GNP inflator we are projecting 6.4 percent.
Dr. SANTOW. 7 percent.
The CHAIRMAN. Dr. Eckstein, you had a fascinating indication of
the fact that you assumed that there was zero chance that the M1
range would fall beyond the M1 range and go below the 4 percent
increase. I agree with that. I have been almost insulted by the Federal
Reserve's-I have been insulted, I'll put it that way, by the Federal
Reserve's target, their range. It doesn't make any sense to have this
big a range. When we put this together we wanted some indication
of what the Federal Reserve's goal was for the monetary aggregates.
When they give us an enormous range it doesn't make any sense.
They had an M 1 aggregate range from 1 percent to 6 percent for the
short-term M 1 • That was a month or so ago. Now you say they have
no change whatsoever of going below their range. Would it make
sense under these circumstances for them to narrow their range?
Would there be a benefit from that?
Dr. ECKSTEIN. We did another study. We did an experiment in
which they aimed to achieve a 4-percent. That is, they really hold
down the nonborrowed reserves so low that the model in the single
value calculation produces 4 percent in M 1 growth, but if you do
that, you get an 11-percent in the funds rate. You get a credit crunch
of great severity. I assume that's not the goal of the Federal Reserve.
The CHAIRMAN. Do you see any difficulty in making the range 5 to
61/2 percent? Is anything wrong with that?
Dr. ECKSTEIN. No. A range of 5 to 6½ percent would be very
satisfactory.
The CHAIRMAN. Now I'd like to ask both you gentlemen, given your
economic projections for next year, what would be the growth rate
changes for the monetary aggregates over tha.t period? Dr. Eckstein,
for M 1 , what would be the appropriate growth rate range for M 1 ?
Dr. ECKSTEIN. Well, our scholastic exercises make it difficult to
estimate that because the range has so many things not under the
control of the Fed.
The CHAIRMAN. You made that clear in chart 6.
Dr. ECKSTEIN. Now again, as a target to be set as the mean of distribution, recognizing apologies may be due a year from now if they
exceed it, we think that a 6½-percent money target is a reasonable
target for M 1 •
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Federal Reserve Bank of St. Louis
28
Dr. SANTOW. I think I have made it clear that I would bring the
M 1 growth rate down slowly so I would say probably about 6 percent
would be a reasonable rate of advance.
The CHAIRMAN. M2?
Dr. EcKSTEIN. On M 2, the same logic applies so the current target
is satisfactory.
The CHAIRMAN. 6½ to 9i
Dr. ECKSTEIN. Nine percent is a good target.
The CHAIRMAN. Nine percent?
Dr. ECKSTEIN. Yes, for M2 •
The CHAIRMAN. All right. Dr. Santow?
Dr. SANTOW. Eight percent.
The CHAIRMAN. All right. Ma?
Dr. ECKSTEIN. Well, Ma poses a problem because they brought that
down and 10½ is a better target for Ma, although I recognize the
symbolic situation at this time. With a few months bad inflation
history it may be better to apologize for failing to have reached that.
Dr. SANTOW. About 10 percent.
The CHAIRMAN. My time is up. Senator Lugar.
Senator LuGAR. Both of the witnesses have brought to the fore with
some clarity the problem of having a monetary policy oversight while
at the same time taking a look at budget deficits that are horrendous.
This whole conversation seems to have an Alice-in-Wonderland
quality.
For example, as I just heard the colloquy between the chairman and
you gentlemen trying to specify ranges for M 1 , M 2 and Ma, in the
face of the fact that the budget deficit that we may be voting on the
floor, is clearly $57 billion-plus, maybe more than that. My first
question to both of you is, granted that monetary policy may be a
partial stymie that may offer a psychological block to inflation, is it
even reasonable to be discussing monetary policy within these ranges
given the budget deficit that is being discussed in other forums?
Dr. Eckstein, you mentioned the full employment deficit and how
that might come into balance by 1983, but that of course is a very
different sort of assumption than the $57 billion variety that I was
discussing earlier on and which Dr. Santow has addressed himself to.
Really what can be anticipated with a monetary policy in any
range, given this size of the debt and the trend for the debt to grow
larger?
Dr. ECKSTEIN. Senator Lugar, when we did our analysis of the
monetary targets, we did not assume, ,our recommendation on the
budget. We assumed a realistic assessment of the budget which is
pretty close to the joint congressional resolution we think that will
in fact continue and that's even in our forecast, but it does assume
pretty much the present fact. So the figures I have given are consistent with a situation where the money and the fiscal policy are not
resolved and what I then really say, in effect, is that the Federal
Reserve considers that as part of its logic and therefore ups their
rates a little bit more. But there's no question in my mind that the
goals of the Federal Reserve are simply more conservative than the
goals of the rest of the Government.
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Federal Reserve Bank of St. Louis
29
Senator LUGAR. What sort 0£ a dilemma does this pose? For instance, the chairman in his questioning consistently raised these questions. I don't necessarily disagree that raising interest rates onward
and upward has a lot 0£ sad effects on the economy and all sorts 0£
components 0£ it, but where does the Federal Reserve Board find itself
in a situation politically in which the Congress and the President are
still determined to have deficits 0£ this size-where really are we
headed ultimately with monetary policy except to say that interest
rates are too high and therefore we just sort 0£ give up the game
altogether? Isn't there a tendency at this stage, given the secular
increase in inflation, £or the Federal Reserve Board to be forced to
higher and higher interest rates over the course 0£ time and is there
any relief in sight from this?
Dr. ECKSTEIN. Well, the Federal Reserve is relatively independent
and the question then becomes how can they best exercise this independent power. The Federal Reserve cannot dictate to the rest 0£ the
Government or to the country what the path 0£ the economy should
be. When it attempts to do that as it did in 1974, you get a very
severe recession. We had a near depression out 0£ that kind 0£ a clash
and I believe that they have learned-certainly Dr. Burns learned
and perhaps his successor as well-that the central bank cannot
substitute its judgment totally £or the judgment 0£ the rest 0£ the
political process. All it can do is moderate the outcome to a moderate
degree. That's really what we're asking them to do.
Furthermore, the Federal budget stands a reasonable prospect 0£
improving after fiscal 1979, and even in 1979 if the tax cuts are reduced. The 1979 budget-and we pointed this out at the time it came
out-is simply too aggressive and the Congress hasn't passed it yet
and I urge you not to.
Senator LUGAR. Dr. Santow, following on Dr. Eckstein's admonition that the budget is too aggressive and that we ought to tailor it,
you have offered an outline 0£ goals in which this might occur incrementally over several years that I think is intriguing. Would you
expand on your advice really with regard to the budget this year
because this plays a very heavy role in your analysis 0£ where monetary policy could take us and you talked about the budget and interest
rates side by side quite appropriately, but what should we be doing
as a Congress or as Members 0£ the United States Senate presently
debating this budget?
Dr. SANTOW. I believe I have made this clear. We ought to have an
8 percent ceiling this year on Federal spending and 6 percent ceiling
in the following year. One 0£ the problems we now have is that the
congressional budget committees are going through on-the-job training and they are using dollar spending ceilings that do not indicate the
full gravity of the size of the increase.
Turning to the concept 0£ underspending, with a few exceptions
it really never did occur. We are going to have an increase this year
in Federal spending 0£ 12 percent which after 3 years 0£ a recovery is
a ludicrous increase, and the £act that 15 percent has been recommended is even more ludicrous. I£ Congress had been working with
increases in percentage terms, it might have added some fiscal
frugality.
28-083 0 - 78 - 3
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Federal Reserve Bank of St. Louis
30
Senator LuGAR. Now on the 12 percent, 12 percent :from what to
what? I'm not certain I follow.
Dr. SANTOW. This year, Federal spending will go up approximately 12 percent, :from $401 billion up to $453 billion, about a 12percent increase.
Senator SCHMITT. That's outlays?
Dr. SANTow. Yes; and I think that's going to be within a couple
billion of being right. One of the problems with respect to the current
budget picture is the £act that while the administration's estimates
for expenditures next fiscal year of about $500 billion should prove
to be quite accurate, if basic conditions are not changed, the receipts
estimates are not accurate. The receipts estimates are too high. With
a tax reduction plugged in, a receipts estimates next year of about
$440 billion or even more, is just too high. Thus, you are going to
see a much larger budget deficit. You think you are going to hold the
deficit to $57 or $58 billion and still have a $20-some-odd billion tax
reduction. 1£ you pass the tax reduction you will have a deficit of $65
to $70 billion because the receipts will not come in at that $440
billion level. I think I have made it very clear that I would not pass
the current tax reduction bill. I would spread a tax reduction out
over 5 years, $8 to $10 billion each year in order to minimize the
revenue loss. We don't want to lose $20 billion of revenues since it
will not be made back in tax receipts and will make it almost impossible to cover the increase in spending.
Senator LuGAR. What is your counsel on the spending, whether it's
5 or 1 or 498 or thereabouts, where does that £all with regard to the
plan of incremental budget balancing you presented?
Dr. SANTOW. It's an increase I think of about 9 to 10 percent. As I
said, if I had my choice, I would hold the increase to about 8 percent
which would be about $35 or $36 billion, and that would mean spending of about $490 billion which is a level that seems much more
appropriate.
Senator LUGAR. That's roughly a $10 billion decrease in the President's budget on the spending side?
Dr. SANTow. Correct.
Senator LuGAR. And then on the revenue side, you're postponing
or at least stretching out very substantially the tax reduction because
otherwise you're projecting we could run into a deficit of $65 to $70
billion if we went straight ahead with the tax reduction and all the
spending?
Dr. SANTOW. Right now that's my best estimate. That's not merely
a £ear, it's my best estimate.
Senator LuGAR. 1£ that occurred and it becomes apparent we're
heading to $65 or $70 billion, what are the effects on monetary policy?
Dr. SANTOW. The Federal Reserve will tighten it too much.
Senator LUGAR. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Schmitt.
Senator SCHMITT. Thank you, Mr. Chairman, and I thank our two
witnesses. I found it very intriguing testimony, and Mr. Santow's
discussion of goals are very similar to the ones I jotted down on an
airplane last night, so obviously I like that.
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Federal Reserve Bank of St. Louis
31
I would like to draw both your attentions to the charts in the back
of the room which the minority members of this committee have
prepared and included in the report from last year, and just ask you
to comment on those trends from 1950 to approximately the present. 1
The first one is the change in the money supply, M1, The second
is the relation between GNP and M 1 , and the third is the correlation
between the rate of inflation and the Federal funds rate. Do you
gentlemen agree with the general averaging that's been done there?
Do you think it's significant?
Dr. ECKSTEIN. I assume that the calculations have been done correctly. They look familiar. As for the substance of the charts, they
really reflect-at least two of them reflect-indeed, all three reflect
the fact that after the period of the Korean war we had a limited
period of worsening inflation with a happy period of the 1960's. The
money supply response to the increased volume of transactions partly
facilitates that. The nominal GNP is bloated by inflation. The problem is how do you get this straight line to become a curve which decelerates and doesn't go up and up through the ceiling.
Senator SCHMITT. Exactly. Not only the ceiling, but to try to reduce
that gap between real GNP and the rate of growth of the nominal
GNP which is a rough measure of inflation.
Dr. ECKSTEIN. Well, my recommendation is fairly simple. You
need a prudent budget policy of the type I described. You need a
money policy which doesn't become overly heroic but does fight
inflation within limits of their ability, and you need other measures
such as those in the President's program to try to reduce the amount
of inflation created by the private sector and policy not related to
demand.
The process will be slow unless we are prepared to impose price
controls, which hardly any sensible person considers. It is going to
be a drawn-out process to work our way out of the inflation into
which we stumbled over 10 years. It can be done on a deceleration of
a half a percent a year if we toughen a variety of policies, such as
agriculture and regulation and a long list-and payroll taxes and
what have you-and if the President uses at least a bit of his good
offices to try to get key price and wage decisions to come out a little
better for the public.
Senator ScHMITT. Dr. Santow, would you like to comment?
Dr. SANTOW. I have commented on these points in other hearings.
The Federal Reserve, to be quite frank, does not have considerable
control over the money supply. They never have. I'm not sure that
they ever will. That's one of the problems we've got when we start
talking about 5 or 6 percent money supply targets. I think that such
a narrow M 1 range overestimates their capabilities in this regard.
Another problem in analyzing Fed policy and money supply
growth is that we don't know how much is cause and how much is
effect. It could be grossly unfair to the. Fed to say that those wide
M1 fluctuations were due to Federal Reserve actions and Federal
Reserve policy. Some of the wide M 1 fluctuations are no doubt due
to the Fed and some are not.
1
See S. Rep. ·95-610, Dec. 7, 1977.
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Looking at the chart on the right, all that chart indicates is that
the Federal Reserve reacts quite quickly to jumps in consumer prices.
In a cost-push inflation, such as we had in the mid-1970's, Fed tightening proved to be quite ineffective in stopping inflation, at least in
the short run. Thus, Fed firming at that time showed considerable
effort but for a long period not a great deal of success before they
finally managed to substantially cut back inflation. Obviously, in a
cost-push inflation Fed policy has minimum effectiveness.
Senator ScHMITT. Well, now the charts aren't necessarily meant to
be a commentary on the Fed and how successful they are. They are
just to reflect history. And the biggest concern, of course, is that
there's this general upward trend. We have been unable to put a
damper apparently on the growth of the money supply. At the same
time we have been unable to really increase our real GNP, and the
two correlate very directly I think in most people's minds with the
inflation rate that we have.
One thing that disturbs me a little bit about what has been said
here about the private sector-and I include labor as well as management in that-is that they have a significant amount of control
over inflation. I'm not sure that they do. Generally, they tend to be
reacting to inflation that's already there rather than creating it
themselves.
Now I agree that there are certain instances where a wage negotiation may be unfair to one side or the other, particularly on the side
of labor, and you get a large increase in wages beyond productivity
increases and, therefore, that would be a contributor to the inflation
rate; but don't you believe, in general, the private sector is reacting
to inflation rather than creating it?
Dr. SANTOW. I think your point is a good one. However, while the
private sector may not create the initial causes of inflation, it can
help to create an inflation bandwagon. For example, when an incomes
policy is instituted, if the incomes policy doesn't work and there are
some large price increases or large wage settlements, this can often
create a snowballing type of effect. So while the business community
of the labor unions may not have created the basic problem, they can
be involved in a process which adds further momentum to the inflationary process.
Dr. ECKSTEIN. The difference in the attitudes of people in the private and public sector isn't all that great. In a way, the Congress and
the administration and the Federal Reserve are situated very similarly to a business leader or a labor leader. There is the inflation.
The point is, you would like to get out of the inflation, and you will
not unless there is a general feeling that some sacrifice is required
from all parties. That includes the Congress controlling spending.
It includes the unions not pushing for that final penny in the cases
where they are exceptionally powerful. It includes the case of the
largest businesses that they give some consideration to the overall
problem when they set their prices.
Senator SCHMITT. I agree, but isn't the long-pull intent the question
of what the Congress is willing to do with respect to holding down
the deficit, reducing the deficit? Because it's only a limited amount
of time that labor and manag~ment can hold their discipline. If the
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33
Congress continues to pump $60, $70, and $80 billion annually into
the economy, the major force on inflation is there, and sure, there
can be discipline for a year or two maybe, but it can't be indefinite
or business and labor both start to go in the hole.
Dr. ECKSTEIN. Well, inflation is the handiwork of everybody, and
big mistakes have been made in the past, the most prominent being
the :financing of the Vietnam war. The current deficit is still largely
the result of the economy being relatively weak. There would be
somewhat less inflation if the budget were straightened out, but if we
would get rid of these budget deficits it would not all by itself cure
the inflation. You would still have the hangover from the past. You
would still have costs feeding on each other and producing rising
inflation. The tragedy of it is that there isn't any one action that can
get us out of it. It's really a common trap. We can only get out of it
with some kind of coordinated approach where private and public
and fiscal-Senator ScHMITT. I agree that it's going to take a coordinative
approach. It's going to take many different policies acting together,
but there is a tendency, at least in the administration's policy, to say
that labor and management, the private sector, is more of a culprit
than is the administration and the Congress. I think we've got to
realize we are all culprits, as you both I think are saying, but that
without fiscal discipline on the part of the Congress, monetary discipline on the part of the Fed, and in £act regulatory discipline on
the part of the administration, it's awfully hard to expect the private
sector to hold the line very long. I think they can hold it for a year
or two, as I say, but you're going to reach a point where the internal
pressures that exist even now on individuals are so great that they
are going to have to let go.
Thank you, Mr. Chairman.
The CHAIRM~N. Thank you, Senator Schmitt. I just have a couple
of quick questions. ,ve have another distinguished panel :following
you.
First, I would like to have both of you give me your frank evaluation of the current reporting system of the Federal Reserve, their
quarterly reports to Congress. I would like to get your recommendations on how the reports to Congress can be improved, and your
judgment on whether economic :forecasts by the Federal Reserve
would impair its independence or its ability to set monetary policy.
Dr. ECKSTEIN. I see no reason why the Federal Reserve should not
make its :forecasts public. By now there are so many of them, no
one would impute to them any more :foresight than one would impute
to anyone else's.
The 9HAIRMAN. Even though you would have a new and prominent
competitor?
Dr. ECKSTEIN. That is implicit in my remark, we are not afraid of
them.
The CHAIRMAN. You answered the last part of the question. How
can they improve their reports to Congress, in your view?
Dr. ECKSTEIN. It is a little hard for an outsider to discuss that in
specific terms. Clearly, they could provide more material on how
they reached their conclusions, for example, the kind of material
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I brought here this morning could be provided by them. There are
some kmd 0£ analytical exercises that underlie their conclusions which
I am sure are first quality work, because the Federal Reserve has an
outstanding staff and which would do well in the free marketplace of
ideas.
The CHAIRMAN. Wouldn't it be helpful to us to understand why
they reached the aggregates they did, the goals of the monetary
aggregates, by spelling out what that would mean in terms 0£ employment, in terms 0£ inflation, areas we can understand, discuss, and
that will mean more to the Congress and to the public?
Dr. ECKSTEIN. Indeed in my testimony this morning we have tried
to show them some ways in which they could do it. So there is a way
to indicate uncertainty, along with forecasts.
Dr. SANTow. I have some strong feelings in this area. No. 1, I
really don't like the current system, with the Federal Reserve coming
back every quarter and giving new annual growth rates; it turns
attention away from the Fed's performance in previous quarters.
The current approach can also be quite misleading.
The committee would be much better off if it asked the Fed at
the beginning 0£ the year for a target range on a single monetary
aggregate. In any given quarter if that indicator proves misleading,
the reasons can be explained. As an example 0£ such an approach, the
Fed would have come before the committee at the beginning 0£ this
year and state that they are going to aim £or a money supply growth
rate 0£ say 4 to 6 percent or 5 to 7 percent for the calendar year. The
Fed Chairman would have to come back every quarter and tell how
well they are doing with respect to the established target range and
why there were any deviations. They should not make new fourquarter estimates each quarter, but should instead explain how well
they are doing with respect to the target range established at the
beginning 0£ the year. This would create some accountability during
the period.
I would also have the Fed establish likely Federal funds rates
consistent with the monetary aggregate target presented. For example, in early January if they would have used a 4- to 6-percent M 1
target, they might also have said this range would be consistent with
a funds rate 0£ between 6½ percent and 8½ percent by yearend.
Every quarter the Fed would be required to testify on how they are
moving compared with these paths and to explain any deviation ..
This approach would definitely improve accountability.
The CnAIRMAN. That is an excellent suggestion. I think we will
do exactly that, to the extent we can in the short time we have
available tomorrow. I think it is a good time to do it because obviously Chairman Miller can't be held responsible for the goals that
were set or the performance since he has been Chairman £or only a
short time. But it indicates how the Federal Reserve as an institution
has been able to £unction in the last reporting period.
Dr. SANTOW. I think you have to use this target approach for both
Fed funds as well as for the money supply. Moreover, don't muddy
the waters by trying to use many varieties 0£ the money supply because this allows people to choose the "M" that best suits their needs
or justifies their case.
[The following information was received for the record:]
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RESPONSE TO A 1 /lTESTTON ASKED HY Sl•:N1\Trn: PROlCMTHJ<:,
C!IAlRMAN OF THE SENATE BM1'.1NG COf1:'ITTTEf:, ON ]]()I.I
TO MAKE THE TESTIMONY OF A FEDERAL HESERVF C!IATRMAN
MORE MEANINGFUL
BY
DR. LEONARD J. SANTO\./
SENIOR VICE PRESIDENT AND ADVISOR TO THE BOARD
J. HENRY SCHRODER DANK & TRUST CO.
NEW YORK
With respect to the Federal. Reserve Chairman testifying before
the Senate Banking Committee, I offer the following suggestions and
procedures to be followed:
(1)
Approximately two weeks after the President has presented his
Budget message and Economic Report in late January-early February,
the Chairman of the Federal Reserve should testify before the
Senate Banking Committee.
(2)
In his testimony at that time he should address himself specifically
to the following points:
(a)
What estimates in the President's Economic Report or the
Budget did he disagree with and what would be the Federal
Reserve 1 s estimates in these areas.
(b)
(3)
What targets or goals in these reports did the Federal
Reserve believe were inappropriate or unrealistic and what
are the Federal Reserve's targets or goals in these areas.
A statement should then be made by the Chairman giving the Federal
Reserve's M-1 growth target from the fourth quarter of the previous
calendar year to the fourth quarter of the new year. The M-1 growth
target should have a 1% range. After this target range is stated,
then the Federal Reserve Chairman should further state whether
it can be achieved by the current level of Federal funds rates.
If not, then how much per quarter would the funds rate need
to move up or down in order to achieve such an M-1 growth target.
A range of 1/4% for each quarterly period should be used when
specifying such changes in the funds rate. To be specific,
the Chairman might state that the Federal Reserve wants an
M-1 growth from the fourth quarter of 1977 to the fourth quarter
of 1978 of 5% to 67,, and that in order to achieve this growth,
the funds rate would probably have to be unch.111gcd to up 1/4%
per quarter in order to achieve this M-1 target.
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(4)
The Chairman should then state that i[ his M-l ,1nd
did materialize wlrnt the likely rate effrct would
U.S. Treasury obligations. Again, the information
stated in terms of quarterly interest rate changes
range per quarter used.
(5)
Approximately one week after the Chairm,m has made his presentation,
several people outside the Government should be asked to testify,
with emphasis placed on analyzing the Chairman's comments.
(6)
The presentation by the Chairman in early February would be
the only one during the year when four-quarter targets or
expectations are given. In his next three quarterly presentations,
the focus would be on how and why the Federal Reserve has deviated
from the numbers presented in February. Therefore, the focus
would be on the current calendar year and there would be no attempt
to use a continuing four-quarter outlook as is done now.
(7)
Again, a week or s6 after each of these quarterly updates by
the Chairman, experts from outside the Government would testify
as to the appropriateness of Federal Reserve policy and the
Chairman's statements.
(8)
In order to make the Chairman's testimony as meaningful as possible,
an attempt should be made to stay as close as possible to the
practical side of monetary policy, and to avoid becoming sidetracked
by theoretical differences. For example, with respect to the
monetary aggregates only the growth target for M-1 should be
given. If the Federal Reserve Chairman wants to state why for
a certain period M-1 is not the most meaningful indicator, it
should, of course, be his prerogative to do so. However, what
should be done is to get away from allowing a continuing shift
of emphasis from one "M" to another based on what suits one's
needs or desires. Hopefully, by using one monetary growth target
and two interest rate changes (Federal funds and long-term Treasury
issues) in the Federal Reserve's early February presentation,
the running battle between the monetarists and Keynesians, which
frankly has no place in these hearings, can be limited.
(9)
Finally, when the Chairman makes his presentation in early February,
the initial part of his discussion should be an analysis of what
happened over the previous year, addressing himself primarily
to Federal Reserve's targets and estimates made a year earlier.
Emphasis should be placed on the deviations from those expectations
and why they occurred.
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funds rates
be on 25-year
would be
with a 1/4%
37
(10)
llhile the H-1 target range that is presented by the Chairman
in February will not be changed during the course of the· year,
the Federal Reserve should be allowed some latitude without
severe criticism for being modestly outside the target range
if important factors are not working out as expected, However,
in the May, August and November presentations no new M-1 ranges
should be given but rather justifications for being outside
the range presented in February should be stated, Staying
with
the initial range will avoid the Federal Reserve changing
the target range every quarter and thus reducing the ability
of Congress to measure how accurate the Federal Reserve was
in its February targets and estimates.
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The CHAIRMAN. Dr. Santow, Chairman Miller has been quoted as
thinking about the need to raise the ceiling rates on time savings
deposits. Do you think this would be appropriate, and what would
be the effect on the mortgage interest rates and the availability 0£
fonds £or housing?
Dr. SANTOW. No. 1, assuming that my interest rate forecast is
relatively accurate and Federal funds rise, when fonds reach 7½
percent, raising the ceilings will become a burning issue. I think
there is a reasonable chance that such a change will happen, and the
increases would probably be a quarter or a hal£ percent. However, I
do not think it will do the economy or housing market a great deal
of good unless the funds rate were to stop its upward movement. 1£
the funds rate were to stabilize, it would definitely help savings inflows into the financial institutions.
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GROWTH OF MONEY STOCK, M1 AND M2, QUARTERLY
(Seasonally adjusted compo111d annual rates)
·
10
M1
I
6
Q.
4
2
Period
ending
with
,o
20
30
40
2Q
- - - - - - - 1 9 n - - - - - - ~ ~----1978;----
12.----------------------------,
M2
8
4
2
Period
ending
with
20
3Q
4Q
,o
2Q
- - - - - - - 1 9 n - - - - - - ~ ~---~1978---Data Source: Calculated from money supply series of The Board of Governors of the Federal Reserve System,
as revised in March 1978.
Prepared by Congressional Research Service, Library of Congress
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GROWTH OF DEPOSITS AT SAVINGS AND LOAN
ASSOCIATIONS, CREDIT UNIONS AND
MUTUAL SAVING BANKS, MONTHLY
(Seasonaly aqusted compoood annual rates)
25 ,-------.,,.--,,,,,-.,,,,..,...,.,,,..-------------,
NBERPeak
20
15
I 10
IL
5
0
1972
1973
1974
1975
1976
19n
1978
25
20
i
15
~
IL
10
5
Period
ending ~ ~ D , ; :
wlthAMJ
JASOND
J
FMAMJ
- - - - - 1 9 n - - - ~ '-----1978--Data Source: Board of Governors okhe Federal Reserve System
Prepared by Congressional Research Service, Library of Congress
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FEDERAL FUNDS RATES
8......-----------------------,
7
5
4
AMJ
JASON
DJ
F
MAMJ
------1977-----~ ~---1978----
QUARTERLY CHANGE IN FEDERAL FUNDS RATES
100
80
I
60
a.
·III
m
40
20
Period
ending
with
20
3Q
40
Data Source: Board of Governors of the Federal Reserve System
Prepared by Congressional Research Service, Library of Congress
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Federal Reserve Bank of St. Louis
10
20
1977 - - - - ~ ' - - - - ~ 1 9 7 8 - - -
42
MONEY SUPPLY (MU GROWTH RATES AND
TWO MONTH FEDERAL OPEN MARKET
COMMITTEE TARGET RANGES
14 ~ - - - ~ ~ - - - - - - - - - - - - - - - - - - - - - - - - - - ~
Actual g r ~ rates
12
~
10
l
a
_.,,
r-
ending
with-
J
F
M A M
J
J
A
S O
N
O
J
F
M A M
J
J
A
S
O
N
D
J
F
M A M
J
J
A
S
O
N
O J
F
M A
'-----1975----' ~---1976----' ~---19n-----''---1978
SOURCE: Targat rengn are from Fed. .l Open Market CommittN Reconfs of Policy Actions. Actual growth rates ara
ca6culned from fflOl'leY lllpply wies of tne eo.rd of Govemon of the Fedel'al R..-ve System as of Mardi 1978.
FEDERAL FUNDS RATES AND FEDERAL OPEN
MARKET COMMITTEE TARGETS
10.0
8.0
.
...•
6.0
l:
e
4.0
J FMAMJ JASONOJ FMAMJ JASON OJ FMAMJJASOND J FMA
'---1975 _ _ ; ' - - - 1976 _ _ ; ' - - - 19n _ _ ; '-1978
from F...,_. Open ,,.ket CommittN Records of Policy Ac:tionr. Weakly.._. of f--.J funds ma
SOURCE: T•gtt rang111 _.
■N from tha Bo.-d of Gowrnon of the Federal R_,.,. Sylt9m data wi•, 1CCIINCI from data files of Data Rnour011, Inc.
,,.._,_. by Congrauional RIIINrd!
Sarvica, Library of Congrea.
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43
The CHAIRMAN. One of the reasons you have these first three charts,
you have an indication of what has happened to the savings and
loans, and particularly the third chart, and there is a disintermediation, a milder disintermediation as a matter of fact, because it is
harder to take money out, money is not flowing in the way it has
in the past.
This would tend to counteract that, if we raised the ceiling on
time and savings deposits to recognize the increased competition.
Dr. SANTow. I think the real problem is what I stated before, and
that is the funds rates will be too high at that point. Even the current
7-percent funds level creates a disintermediation problem.
The CHAIRMAN. Senator Lugar~
Senator LUGAR. No more questions.
The CHAIRMAN. Senator Schmitt~
Senator ScHMITT. Just that if you gentlemen would, for the record,
provide us with your short- and long-term assessment of the effect of
productivity changes on the problem of inflation, and our balance
of payments, I would appreciate it.
We didn't really get into productivity today, but that is another
factor that does relate to this problem, and I would appreciate any
comments you might have on that for the record.
Dr. EcKSTEIN. Productivity performance, we have analyzed this,
and concluded that after the substantial decline in the trend in the
late 1960's, there has not been a second major stepdown in our productivity advance. There is a current poor performance, and it is
due to the current business cycle circumstance; indeed, we expect a
big productivity gain in the second quarter. Longer term, the United
States is clearly neglecting productivity performance; we are shrinking our commitment to research and development. I see the best
students where I teach mainly going into law or medicine, and
hardly any into technology. The opportunities are not there any
more, our tax system is not that conducive to investment.
The only thing we have going for us is an industrial relations system that is better than most countries, which stm has our labor force
trying pretty hard on the job.
Senator SCHMITT. Dr. Santow ~
Dr. SANTow. Frankly, I didn't find the first quarter economic
results very consistent. It appears that the productivity figures in
the first quarter will be awful because total employment went up by
quite a substantial amount and overtime seemed fairly strong, yet
real GNP went down. Possibly, we will see some revisions in the
economic data for the first quarter that will put real GNP on the
plus side.
I believe Dr. Eckstein is right, the big jump in the second quarter
in the GNP will cause a snapback in productivity, at least for one
quarter. However, I am deeply concerned over productivity on a
longer term basis. With a $27 billion trade deficit last year and a
similar amount this year, there is reason to be concerned over productivity.
Senator SCHMITT. Have either of you analyzed the effect of Federal
regulations on productivity~
Dr. ECKSTEIN. No.
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Dr. SANTOW. I have not.
Senator ScHMITT. Thank you very much.
The CHAIRMAN. Thank you, gentlemen, very much for a most helpful and enlightening presentation.
Now we are honored to have a distinguished panel of three outstanding economists. I am happy to introduce them.
Prof. Donald Hester, who hails from the University of Wisconsin,
I am happy to say, where he is a professor of economics. And he is
Yale educated, I believe.
Dr. Thomas D. Thomson, first vice president, and chief economist
of the Detroit Bank & Trust. Co., and who is Indiana University
educated. I think Senator Lugar will be interested in that.
Then we have Prof. Joan Walters, with a fine background, who,
incidentally I might mention is listed in American Men of Science,
among many other honors. So we will start off with Professor
Hester. We are going to give you a suggestion here with a little
Jight. The green light will be on for 9 minutes, then the yellow
light for a minute, and then the red light.
I am going to have to leave, because of the persuasive arguments of
Senator Lugar and Senator Schmitt, I am going to the floor at 11 :30
to introduce a resolution which would put a ceiling on spending at
$475 billion.
This committee, incidentally, is unfortunately typical of a microcosm of other committees up here, we are going to entertain proposals to increase the President's budget by over $1 billion in the
next few days, when we come to mark the budget up. This is the kind
of very tough problem we face. The proposals come from both sides
of the aisle.
But we are happy to have you, Dr. Hester, go right ahead.
STATEMENT OF DONALD D. HESTER, ECONOMICS DEPARTMENT,
UNIVERSITY OF WISCONSIN'
Dr. HESTER. Thank you very much. In my statement I have not
made many statements about the current situation, because it is
changing so. rapidly and I anticipated that. I will just make a brief
statement, because other speakers have spoken more about the present
situation.
I think it is important to have a broad view. I was very concerned
about the increase in the funds rate to 7 percent, and I anticipate
that it will be going up an additional quarter or half percent in the
next few weeks. If that should happen, I think we will have serious·
disintermediation. The economy is not as strong as you have been
hearing. Quarterly changes in real GNP have declined steadily since
the first quarter of 1977. The current decline, an absolute decline in
real GNP has been attributed to the weather. I would call your
attention to the fact that in the first quarter of 1977, which was also
part of a bad winter, GNP grew very rapidly. So I think you should
not just write this off to the weather. I am not so confident that the
second quarter GNP will be as expansive as others have projected.
Therefore, I would urge a looser monetary stance and a lower Federal
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Federal Reserve Bank of St. Louis
45
funds rate target by the Federal Reserve, and I would also be very
opposed to reducing the tax cuts that are proposed.
My testimony adequately indicates that I am also concerned about
the size of the deficits, but I think there are a tense few quarters
coming up and I don't think that one should err on the side of being
tight at this point.
Now I will briefly summarize my statement. The statement takes
a different perspective than other statements you are hearing today,
partly because I think some important institutional changes have
been occurring in the capital markets. These have not been adequately taken into account when people are making statements about
targets for monetary aggregates. I don't want to go through this in
detail, because time is obviously scarce. Since I understand that the
statement will be in the record, I will skip several important points.
The most important thing, I think, is to realize that the Fed's
ability to control large monetary aggregates-The CHAIRMAN. Dr. Hester, I have to interrupt for a minute. That
bell means the Senate is going into session, we are going to have the
morning hour right away, and I have to make a statement on the
floor. I will be back. The distinguished Senator from Michigan,
Senator Riegle, will chair the meeting in my absence. Go right ahead.
Dr. HESTER. Thank you. The larger aggregates, M 2 and M 3 , have
been growing rapidly relative to M1 and I believe the Fed's ability
to control these larger aggregates is always less than its ability to
control M1. The ability of the. Fed to control broad monetary aggregates has declined. In addition, I think M 1 itself is being increasingly
misinterpreted by monetary and financial analysts.
I want to spend some time talking about that. What has been
happening is that other commercial bank liabilities, nondeposits
liabilities, have been growing much more rapidly than any of the
deposit aggregates. These other liabilities consist largely of Federal
funds purchased and securities sold under agreements to repurchase.
Federal funds purchased are "good" funds that have been purchased
from banks and an assortment of other authorized sellers. A repurchase agreement is a transaction in which a bank sells securities overnight to either a StatJ and local government or a private nonfinancial
corporation, and then buys the securities back from the purchaser the
next morning.
The securities typically are in the bank's portfolio and never change
hands, but are simply put in a different account for the firm at the
bank; in effect they serve as collateral for an overnight loan. The
bank's balance sheet continues to show the securities after the transaction and also shows that the bank has acquired a matching liability in the amount of the funds purchased. These transactions are
undertaken by banks partly to obtain funds at short notice to meet
their reserve ob.ligations. Suppliers of funds benefit from being able
to sell excess funds at short notice and to earn interest on funds that
might otherwise be idle overnight.
In effect repurchase agreements permit the payment of interest on
demand deposits, but they are not counted as demand deposits. Two
features of the transactions make them important for interpreting
monetary aggregates.
28-083 0 - 78 • 4
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46
First, neither Federal funds purchased nor funds acquired through
repurchase agreements are subject to reserve requirements. This means
that a bank can reduce its future reserve obligations if it chooses to
buy _funds from its own depositors.
Second, the transactions are often negotiated so that the seller of
funds does not have to deliver funds until near the close of a business
day. Thus, the seller can use his funds all day long, say, until 4 :59
p.m., when they must be delivered. All day they are money. When
they are delivered the bank does not record the funds as demand
deposits, but shows its liability appropriately as funds acquired
through repurchase agreements. If 5 p.m. is the close of the business
day, that is the time that a bank calculates its deposits and reports
them to the Fed. For purposes of calculating the money stock, the
Federal Reserve only uses close-of-day figures. Therefore funds
acquired through repurchase agreements are not counted as money
even though they may have been used that way all day. If the transaction is an overnight deal, at 9 a.m. the next morning the Federal
funds or repurchased funds revert to the seller's demand deposit
account and thus are available as money all day long again.
Now you might ask how important are such transactions? In order
to answer this question one needs detailed data on the average daily
net Federal funds purchased by the banks in the system, just as
demand deposits are measured. No such information is presently collected by the Federal Reserve. One of the useful things you could do
is to seek better information about this quantity. However, one can
make some rough estimates. Fragmentary evidence has been assembled by subtracting Federal funds sold by all commercial banks from
the sum of Federal funds purchased and securities sold under repurchase agreements by all commercial banks on different dates. This
series is shown in table 2 in my statement.
On the most recently published call report the volume of such net
funds purchased was $45.8 billion or about 15 per:cent of M 1 • In the
previous quarter it was $41.7 billion or 13 percent of M 1 • The 15percent figure refers to September 1977 and the 13-percent figure
refers to .June 1977. The increase in net Federal funds purchased
in the third quarter was on the order of magnitude of the change in
M1, but it did not count as an increase in the monetary stock. Between 1970 and 1976, net Federal funds purchased has grown 14-fold.
There are several other recent technological and legislative innovations that have also changed the spendability and convenience of
consumer-type savings accounts at financial institutions. In addition
to the evolution of the share drafts and No,v accounts, the widespread introduction of electronic tellers for regular savings accounts
has made these interest-paying accounts at least as convenient as a
commercial bank checking account.
Surely the relevant concept, which used to correspond to M1 ,
should be more broadly defined than in the past. A new money stock
measure is necessary in order that these newly transactable balances
be appropriately accounted for within the monetarist framework.
We can make similar statements for small business savings deposits
and for funds of large multinational corporations that appear increasingly to be placed i:f!- offshore banking centers. The latter are
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47
likely to be compensating balances that are placed abroad to evade
reserve requirements on demand deposits that would apply if these
funds had been left in domestic branches. At present, offshore deposits
of domestic corporations are excluded from measures of the domestic
money stock. Little information is published about the extent to
which offshore deposits have been substituted for domestic corporate
accounts.
I would like to turn briefly now to a discussion of velocity and
point out that velocity has been growing very rapidly. M1 velocity
has doubled in the last 25 years. M 2 velocity has risen about 20 percent
in that period of time, although almost all of the rise in the M2
velocity occurred before 1960, when banks began to pay interest in
a competitive fashion on their time and savings deposits.
These velocity measures should not be taken too literally, because
they involve a great deal of very messy aggregation. Velocity is the
ratio of some income measure to some monetary aggregate. Different
components of M 2 have been growing at very different rates relative
to GNP.
In a recent dissertation, a Wisconsin graduate student, Cynthia
Wood, discovered it was possible to analyze each of these components
separately and learn a great deal more about fluctuations in GNP.
An implication of her findings is that there are significant aggregation losses when one sums the components to form M 2 ; each of the
components should be studied separately.
Now I turn to interest rates, because I see my time is running out.
In recent years there has been a great change in the relationship
between the commercial paper rate and the prime loan interest rate
relative to what existed in the U.S. in the preceding 10 or 12 years.
The prime commercial paper rate tends to move very closely with
the Federal funds rate, especially once allowance is made for the
longer maturity of commercial paper. Commercial paper is the basic
rate among the lowest risk nonbanking institutions. Traditionally
that rate has moved closely with the prime loan interest rate. Only
twice before 1974 did these two interest rates differ by as much as
one percent. However, beginning in 1974 the two rates have alway8
differed by at least 1 percent. Evidently a basic structural change has
occurred in the market for loans to "prime" borrowers; borrowers
who do not have access to the commercial paper market recently have
begun to pay considerably more than commercial paper borrowers.
This is disturbing since many commercial and industrial loans to a
broad spectrum of firms are tied to the prime loan rate. Plant and
equipment expenditures have been weak in the current recovery and
commercial and industrial loans at large money center banks have
been very weak. It is surely worth investigating whether the prime
loan rate has been maintained at an artificially high rate, a situation
that would account for both of the foregoing facts.
[The complete statement of Professor Hester follows:]
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48
Money, Velocity, Interest Rates, _aJl_d_J'_g_\i!;_y
D~nald D. Hester
Professor of Economics
University of Wisconsin-Madison
This paper probably presents a minority opinion about how to assess
monetary policy.
At the outset I should state that I believe that all
observable features of money and capital markets -- not just measures of
monetary aggregates
shed light on how monetary policy and economic
activity in general are proceeding.
There are no reliable simple touch-
stones that permit economists, the Federal Reserve, or this Committee to
see whether or not everything is going well.
The next section of this
paper briefly examines the motion of several monetary aggregates in recent
years, and proposes an interpretation.
The second section focuses on the relation between measures of the
money stock and both the volume of transactions in the economy and the
level of gross national product.
It argues that severe informational losses
occur when one restricts attention to a small number of monetary aggregates
or velocity measures, and that technical progress in moving funds threatens
to increase these losses considerably in the near future.
The third section
presents interest rates and attempts to interpret their movements since
1965.
The final section pulls the various strands together and makes
several explicit proposals and suggestions about how policy formulation
and implementation can be improved.
Before taking up this ambitious agenda, there are three important
issues that should command your attention whether or not you are persuaded
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49
by my approach.
I cannot treat them fully and cover my assignment in the
available time.
They are:
a.
Technical problems in controlling monetary aggregates.
The dual
banking system that permits a majority of nonmember commercial banks to
have low effective or nonexistent cash reserve requirements on demand
deposits is a serious obstacle to controlling monetary aggregates closely.
Even member banks have different marginal reserve requirements, a fact that
seriously complicates the task of cont;_rel'Hhg monetary aggregates.
Banks
with off shore branches and subsidiaries have devised a host of complex
techniques for obstructing the control of monetary aggregates that have
been documented by Little (1975] among others.
Finally, reporting by
nonmember banks is very incomplete except on call report dates when data
ate subject to "window dressing".
Therefore, benchmark revisions such as
the substantial revision announced on March 23, 1978 become necessary.
Although you have heard the recommendation before, a strong case still
exists for requiring that all banks and other domestic financial institutions
that offer demand deposits or their equivalent to American controlled firms
be subject to uniform reserve requirements.
As proposed in the recent
FINE Discussion Principles (1976), membership in the Federal Reserve System
should be nondiscretionary.
Better control of monetary aggregates and
equal treatment of equals are ample justification.
b.
Monetary policy and the international value of the dollar.
The
international purchasing power of the dollar has declined sharply in recent
months for several reasons, some of which are suggested in section 4 below.
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50
During the 1960's the exchange value of the dollar was artificially
supported by some major European central banks that sought to perpetuate
a fixed exchange rate system.
Both the recent and the earlier events are
more the outcome of political decisions by the governments involved than
of independently conceived monetary policies.
Central banks may respond
to these situations by intervening actively or by sitting on the side line.
The world has neither a fixed nor a cleanly floating flexible exchange rate
system, so neither response is automatically justified.
Your deliberations
should focus on the extent to which the strategy of the United States in
this very serious confrontation is 1) the outcome of a coordinated plan
involving both the Federal Reserve and the several relevant executive
departments and 2) whether or not that plan makes sense,
c.
Contracts, indexation, and the redistributive consequences of policy.
It is often alleged, and much less often documented, that unanticipated
inflation has substantial redistributive effects on the economy.
These
effects are the consequence of contracts and agreements which must exist
if production is to be coordinated in a decentralized economy.
(Contracts
and other enforceable agreements are the "laissez faire" counterpart of the
11
plan1t in socialist economies.)
Because people consume and firms produce
very different bundles of goods in a decentralized economy it i s ~ feasible
to index contracts fully against inflation.
Often people justify policies
designed to combat inflation on the grounds that they serve to protect
society from divisive redistributional struggles.
their argument, but it is seriously incomplete.
severe redistributional effects.
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There is some merit to
Policy itself often has
In my view the 100-year-high interest rates
51
that occurred in 1973 and 1974 were largely the consequence of restrictive
monetary policy and were the major causative agent underlying the recent
mini-depression; an experience from which black unemployment has yet to
recover.
Large firms and affluent individuals can partially escape the
burdens of inflation by dealing in a rich variety of assets and in
financial instruments whose interest rates float freely, but middle-class
America and small enterprises took a severe beating on their demand and
savings deposit bala9ces that were subject to policy determined interest
rate ceilings.
It is important that you verify in your deliberations that
policy induced cures are not more lethal to the American economic system
than the ailments.
·r.
Monetary and Other Aggregates
The definition of the money stock is inherently arbitrary.
words of Friedman and Schwartz:
In the
"There is no hard and fast formula for
deciding .,hat to call 'money' [1970, p. 104]."
This section reviews several
definitions and argues that they are in need of modification.
Table l
provides an historical swmnary of how several measures of money have
evolved since they were first sys~ematically compiled and published by the
Federal Reserve.
I do not report recent weekly or quarterly movements in
these aggregates for, as the announced revisions of March 23 indicate, they
are preliminary; for this and other reasons short-term measures are "noi:~ytt
and are not reliable guides for formulating policy, when taken alone.
The
two widely publicized measures, Ml (demand deposits adjusted plus currency
outstanding) and M2 (Ml plus small denominational time and savings deposits
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TABLE 1
SELECTED MONETARY AGGREGATES SINCE WORLD WAR Ila
Year
end
(1)
Member Bank
Reserves
NSA
(2)
MO
NSA
(3)b
(4)
(5)
(6)
(7)c
(8)c
Ml
SA
M2
SA
M3
SA
M4
SA
DD
TD
OL
CAP
NSA
NSA
NSA
NSA
(9)c
(lO)c
1945
1950
1955
1960
1965
1970
15.8
17 .4
19.2
19.3
22. 2
29.1
NA
42.4
47.0
48.3
58.5
78.2
NA
116.2
135.2
144.2
171.3
219.6
NA
152.9
185.2
217.1
301.3
423.5
NA
NA
NA
319.3
471.7
656.2
NA
NA
NA
217.1
317. 7
448.8
117.9
117.0
141.0
155.7
183.8
247.2
30.0
36.5
50.0
73.3
147.7
235.3
1.1
1.6
3.1
6.7
14.0
51.2
8.7
11.3
15.0
20.7
29.9
42.6
1971
1972
1973
1974
1975
1976d
1977
31.2
31.4
35.0
36.6
34.8
35.0
36. 2
83.8
88.3
96.5
104.4
108.5
115.5
126.2
233.8
255.3
270.5
283.1
294.8
312.4
335.4
745.1
471. 7
525.3
844.9
571.4
919.5
612.4
981.6
664.3 1092.9
740. 3 1237.1
806.5 1374.1
505.0
568.9
634.9
702.2
747.2
803.5
881.2
261.0
294.9
307 .6
312.8
319.8
332.3
332.3
274.5
318.1
369.7
428.8
455.5
492.7
515.0
49.8
59.5
87.3
97.2
96.3
107.0
118.1
43.8
48.1
53.5
58.8
64.1
72.1
75.5
'1 :iources:
Board of Governors of the Federal Reserve System, Banking and Monetary Statistics 1941-70,
Annual Statistical Digest 1971-1975, and various issues of the Federal Reserve Bulletin.
b
M0 is sometimes called "outside money"; it is the sum of member bank reserves and currency outside
banks.
cThese data refer to the domestic balance sheets of all insured commercial banks.
dAll 1977 data are preliminary, except for last four columns which come from the June_!:977 Call report.
0-,
I:,:)
53
at commercial banks), have been available only since 1947; although
researchers such as Friedman and Schwartz (1970] have extended the latter
back as far as 1867.
The broader measure, M3, which includes deposits at
thrift institutions, emerged in 1959 when it became evident that these
institutions were growing much more rapidly than commercial banks.
M4
is M2 plus large denomination certificates of deposit at weekly reporting
banks; it became distinctive in 1961 when CD's be~ame important.
The
purest definition of money is HO, currency outstanding plus nember bank
reserves; it measures direct monetary liabilities of the Federal government. 1
While the Federal Reserve is technically unable to control any of these
quantities exactly, most economists would agree that, with the possible
exception of M4, the Fed's problem of control tends to increase with the
numerical subscript on the monetary aggregate.
The components of M2 and
M3 are quite heterogeneous and thrift institutions do not report their
conditions as completely as do member banks.
It is disconcerting to note
that these less easily controlled aggregates have been growing much more
rapidly than Ml.
Evidently the controllability of the more broadly defined
monetary aggregates is deteriorating with the passage of time, simply as a
consequence of differences in growth rates.
Since 1970 currency, time deposits, and deposits at thrift institutions
have been rising much more rapidly than either member bank reserves or demand
1An early Chicago economist, Henry Simon [1936], was advocatinp, this
pure
definition of money when he urged that bank demand deposits be subject to
a 100% reserve requirement. His successor, Milton Friedman, also urged
that it be given serious consideration at one time (1948].
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54
deposits adjusted.' Before 1970 a similar pattern is evident except that
currency grew at about the same rate as demand deposits; the early pattern
was often attributed to differences in the paths of interest rates paid on
different types of deposits. 2
The post-1970 pattern occurred during a period in which interest rates
on deposits at thrift institutions and on small denomination time and
savings deposits at commercial banks were highly controlled and largely
invariant.
The most likely explanation for the observed pattern is associated
with the occurrence of technical progress and institutional changes that
are mentioned below.
An existing amount of demand deposits can accommodate
more transactions, and a growing volume of transactions balances have been
omitted completely from conventional measures of money.
Fluctuations in large
denomination certificates of deposit can perhaps be interpreted in terms of
fluctuations in interest rates paid on them, especially after regulation Q
ceilings were lifted.
The post-1970 pattern can also be seen in the case of commercial banks
alone if one looks at aggregated domestic liabilities of all insured banks
that are reported in the last four columns of Table 1.
call reports that are subject to window dressing.
All data are from
Nevertheless, it is
apparent that time deposits (which include savings deposits and certificate,
of deposit) have been growing four or five times as fast as demand deposits
2serious technical questions exist about the validity of such interpretations since it is doubtful that behavioral relationships have actually
been identified.
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55
It is also apparent that other liabilities of banks have been growing
even faster than time deposits.
In order to communicate an appreciation
for how the definition of money should be changing, I shall now argue at
some length that a substantial part of these other liabilities are for
all intents and purposes money.
Other liabilities include bankers acceptances, miscellaneous other
liabilities, and debt capital.
But the lion's share, $70 billion at the
end of 1976, are Federal funds purchased and securities sold under agreements to repurchase.
No breakdown of the total into Federal funds purchased
and securities sold under repurchase agreement is published for all
commercial banks.
For the purposes of this discussion it will suffice to
define Federal funds purchased as "good" or "collected" funds that a bank
buys from a) other commercial banks, b) certain Federal government agencies,
c) savings and loan associations and mutual savings banks, d) foreign
commercial banks, and e) certain subsidiaries of a bank holding company.
These transactions typically are overnight transactions, but they may last
for several days.
A rep1 1rchase agreement is a similar sort of transaction
that may be engaged in by a bank with any of the foregoing, but commonly
is between a commercial hank or a securities dealer and eithc.•r a non-
financial corporation or a state or local government.
In this transaction
a bank sells some of its securities to a firm, say, and agrees to buy them
back at an agreed upon price one or more days later.
The securities typically
never change hands, but ,'lre put in a separate account for the firm at the
bank.
The bank's balance sheet continues to show the securities after the
transaction and also shows that the bank has acquired a matching liability
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56
in the amount of the repurchase agreement.
These transactions are under-
taken by banks partly to obtain funds at short notice to meet their reserve
obligations.
Suppliers of funds benefit from being able to sell excess
funds at short notice and to earn interest on funds that might otherwise
be idle overnight.
Two features of the transactions make them important for interpreting
monetary aggregates.
First, neither federal funds purchased nor funds
acquired through repurchase agreements are subject to reserve requirements.
This means that a bank can reduce its future reserve obligations if it
chooses to buy funds from its own depositors.
Second, the transactions
are often negotiated so that the seller of funds does not have to deliver
funds until near the close of a business day.
Thus, the seller can use
his funds all day long, say, until 4:59 p.m. when they must be delivered.
All day they are money.
When they are delivered the bank immediately reduces
the supplier's demand deposit and shows its liability appropriately.
If
5:00 p.m. is the close of the business day, that is the time that a bank
calculates its deposits and reports them to the Fed.
For purposes of
calculating the money stock, the Federal Reserve only uses close of day
figures.
Therefore funds acquired through repurchase agreements are not
counted as money even though they may have been used that way all day.
the transaction is an overnight deal, at 9:00 a.m. the next morning the
Federal funds or repurchased funds revert to the seller's demand deposit
account and thus are available as money all day long again.
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If
57
All overnight repurchase agreement funds and many but not all Federal
funds purchases are money in everything but name. 3
How~ver, Federal funds
purchased by a member bank from other commercial banks s\ould not be counted
\
as money, since they represent only a redistribution of excess reserves
within the banking system.
1 are in fact money?
How much of the other liabilities shown in Table
Very fragmentary evidence has been assembled by sub-
tracting Federal funds sold by all commercial banks from the sum of Federal
funds purchased and securities sold under repurchase agreements by all
commercial banks on different dates.
Table 2.
On
The results are shown in column 8 in
the most recently published call report the volume of such net
funds purchased was $41.7 billion or about 13% of Ml.
this volume had grown twelve fold.
Between 1970 and 1976
Goldfeld [1976] among others has noted
that traditional estimates of the demand function for money began t o ~ estimate the demand for money, Ml, near the end of 1973 by very substantial
amounts.
A plausible conjecture is that this empirical instability is
associated with the contemporaneous (and possibly transitory) rapid growth
of net funds purchased by banks.
Better data than presently exist are
required before this conjecture can be rigorously tested.
Several recent technical and legislative innovations have also changed
the spendability and convenience of consumer type savings accounts at financial
institutions.
In addition to the evolution of share drafts and NOW accounts,
the widespread introduction of electronic tellers for regular savings accounts
3A somewhat similar inference has been reported in an unpublished paper
by Lnmbra and Kaufman [undated].
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58
has made these interest paying accounts at least as convenient as a
commercial bank checking account.
Surely the relevant concept, which used
to correspond to Ml, should be more broadly defined than in the past.
A
new money stock measure is necessary in order that these newly transactable
balances be appropriately accounted for within the monetarist framework.
A similar case can be made for small business savings deposits and for
funds of large multinational corporations that appear increasingly to be
placed in off-shore banking centers.
These funds are likely to be compensating
balances that are placed abroad to evade reserve requirements on demand
deposits that would apply if these funds had been left in domestic branches.
At present. off-shore deposits of dornestic corporations are excluded from
measures of the domestic money stock.
Little information is published about
the extent to which off-shore deposits have been substituted for domestic
corporate accounts.
Other examples can be suggested, but perhaps the point is clear.
The
different components of monetary aggregates, currency, demand deposits,
and various types of time and savings deposits, have been performing very
different functions in recent years as compared to the 1960's.
Technical
progress in data processing and funds transfer has been very rapid; many
new money-like instruments have emerged in recent years.
The relationships
of different money stock measures to one another are likely to have been
permanently altered and to be subject to further large unpredictable chan~es.
In this rapidly changing setting, it is very doubtful that policy can be
reliably based on movements in one or more monetary aggregates.
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59
Figure 1 which is from the most recent annual report of the Federal
Reserve Bank of New York illustrates the point well.
It shows the relation
between actual values and target ranges of Ml and M2 that were established
by the Federal Open Market Committee since 1975.
It is apparent that in the
fourth quarter of 1976 and the first quarter of 1977, Ml was at the bottom of
its desired range when M2 was beyond its upper range.
This situation is
particularly remarkable when it is recalled that 40% of M2 is Ml!
Also, in
the figure it often happens that the quarterly growth rate of Ml is moving
in
one direction when the quarterly growth rate of M2 is moving in the other.
It is hard to steer a car
when its wheels are turning both right and left.
An analysis of interest rate movements and other information about the
economy's inflation and unemployment problems is likely to provide better
guidance than are the wiggles in some monetary aggregate.
II.
The Velocity of Money
In this section information is provided about how fast money has been
turning over and about how money has been growing relative to income.
The
two principal velocity of money concepts that economists use are 1) the
transactions velocity and 2) the income velocity.
The transactions velocitv
concerns how fast money changes hands in an economy and can be only very
approximately measured by the ratio of the volume of debits to balances in
demand deposit accounts.
Income velocity refers to the ratio of income to
money; it is easily measured once one settles on appropriate measures of
income and the money stock.
nominal GNP.
In this discussion the income measure used is
The two concepts of velocity are related if, as seems likely,
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60
Figure 1
MONEY STOCK LEVELS RELATIVE TO THE FEL..£RAL OPEN MARKET
COMMITTEE'S LONG-AUN PROJECTIONS
Ratio 1<0I•
01~---------~----------~-------
lillion1
dollor1
800
•
•
. ~
y~
\
,.,
780
ACTUAL
760
/
·
7••·'•
740
::::
. .,,
680!--
•
!
1
,.,
•
~
,
620}'
. . ,:·•. ."/'
e,n,on1 of
ACTUAL
,
dolla,1
LONG RUN
TARGET PATH
b60L
••ccI
.
\
e
e
:J
330
•-~
320
·•,•.-,,,,,~
:~~~
310
!
JOO
/1:~-~-~···_·~---·-•,_>l~i•~s.,uN
~_....,...
I
111
I
290
IARGETPATH
IV
Ill
IV
-,-
19/6
The lo ,g run ld'l!t'I 1>a!hs Jre construc1Pd bJ e•len111ng J trf'nd 1,ne [1101 \h0•n) tor eJch
mnne!Jry Jl!tre-RJle '•orn ,rs Jdu,1I vJ/ue ,11 the seco11a ,1uJ1ler vi 19]'> JI 11lt',e<j1.1J! ro
H•c rn, !pom[) ot The ... ne V"'J' rJn,:e,; ,l!lUOfCJ ~J~h .JllJr!d Ov !he fOMI.: !t.l' ~tlad<'<1 J/,:!JS
\hown Jre d'J"'n oa· ,'lE"l 10 each ,,,.nc1 hnt> w,th the uf,i't'f Jnd lowf'r t,c,un,h I''•
Jge O•,,nt~ Jl'lo11e a· ,J twiow ,t
!h,., relt~tl~
tt,.-
oeru•111
H}MC, 1,1,1<t1le ul e•Of~~'>Ulil ,h
<:ll't'
yedr µ101ect,on~ a-:, r J'1~e$, wh,cn r,J~I" J,erJ~l"d Jl/vut ."', IJl''lE:UIJJ!lt j.•"''h ,n """ll/'I
Source:
Federal Reserve Bank of New York, Annual Report, 1977.
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Federal Reserve Bank of St. Louis
61
there is ·some relation between the rate that transactions occur and the
flow of income.
Table 2 reports information about two measures of income velocity,
Vl and V2, that correspond to Ml and M2 respectively, and one measure of
transactions velocity, turnover.
All have the dimension "times per year".
The income-velocity of Ml has risen steadily since 1950 although in a
somewhat erratic fashion.
Thus, even if one accepted the economic meaning
of Ml, its relation to GNP, is changing in a way that probably reflects both
technical progress if the payments mechanism and rising interest rates that
are distinctive features of the post World War II era.
In Table 2 it can
be seen that Vl has about doubled in the last 25 years.
The velocity of M2 has also risen about 20% in this period, but most of
the rise had occurred before 1960 when commercial banks first began to
compete aggressively for time and savings deposits by increasing the interest
rates they paid.
An interpretation of the comparative stability of V2 since
1960 is that commercial banks managed to hold their share o~ household
savings balances and that such savings balances have been roughly a constant
fraction of GNP.
If one bothered to calculate a velocity for M3, it would
have fallen over time since M3 has grown much more rapidly than GNP.
It is
not clear that the apparent const~ncy of V2 is more than an historical
accident.
In a recent Wisconsin Ph.D. dissertation, Cynthia Wood [1976] tested
the hypothesis that different components of M2, currency outstanding, demand
deposits adjusted, and time and savings deposits, were similarly related to
GNP and several other macroeconomic variables.
28-083 0 - 78 - 5
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The hypotheses were rejected.
62
TABLE 2
DEPOSIT TUHNOVER AND THE VELOCITY OF MONEY
(1)
(2)
(3)
(4)
(5)
Year end
$GNP 8
(6)
(7)
Debits
Turnover
(8)
Net
Ml
M2
Vl
V2
1950
1955
1960
1965
1970
308. 2
410, 0
514. 7
720.6
1022. 9
116.2
135.2
144.2
171.3
219, 6
152. 9
185. 2
217. l
301.3
423, 5
2. 65
3.03
3. 57
4. 21
4,66
2.02
2. 21
2. 37
2.39
2.42
1.5
2. 2
2.8
5. 2
10,9
23. 2
28. 6
35, 6
48. 1
77. 0
NA
NA
NA
o. 3
3, 2
55, 46
61.94
68. 98
75, 54
93. 69
1971
1972
1973
1974
1975
1976
1117, 3
1238. 9
1359, 8
1470, 9
1617. 7
1798. 5
233, 8
255, 3
270,5
283,1
294,8
312.4
471. 7
525.3
571.4
612.4
664. 3
740, 3
4. 78
4,85
5.03
5.20
5.49
5. 75
2.37
2. 36
2.38
2,40
2.44
2.43
12. 4
14.8
18.6
22. 2
23, 6
28, 9
83. 7
90. 7
110.2
128.0
131.0
153, 3
6. 9
9, 5
19,1
18,5
19. 7
32. 6
98. 01
102. 90
ll0.91
121. 60
130, 53
137. 60
Purchases
(9)
DEFL8
Mid-guarter
1976: l
2
3
4
1651.2
1691.9
1727. 3
1755. 4
296, 5
303. 0
306.4
310.4
678. 5
697. 2
710,8
732, 3
5. 57
5. 58
5. 64
5.66
2.43
2. 43
2, 43
2.40
25, 5
25.5
27. 9
28.1
140. 9
139.4
148.6
147. 2
27. Sb
29, 8
NA
32. 6
131.47
133,06
134. 56
136. 35
1977: l
2
3
4
1810.8
1869. 9
1915, 9
1965. 1
314.0
320.7
328.4
333. 2
750. 7
767. 6
787. 7
802. 6
5. 77
5. 83
5. 83
5. 90
2, 41
2.44
2. 43
2. 45
30.1
32.0
NAc
NAc
153. 3
158. 2
NAc
NAC
36. 5
41.7
NA
NA
138. 13
140. 52
142.19
144. 34
aThe annual figures have been calculated by averaging successive enclosing calendar
years so that the dating of GNP and monetary aggregates corresponds. Both variables
are taken from the 1978 Economic Reeort of the President.
bThis number was interpolated for all commercial banks by using data for all insured
comme re ia 1 banks . All other data concerning net purchases of Federal funds refer to
all commercial banks. All data are from Federal Reserve Bulletins, The Annual Statistical
Digest 1971-1975, or other public sources.
cThe basis for calculating debits and deposit turnover was substantially revised in
June 1977. The reported data refer to 233 clearing centers that were reporting
monthly deposits and debits. The sources for these two series are the same as those
in Table 1.
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Federal Reserve Bank of St. Louis
63
An implication of her findings is that there are significant aggregation
losses when one sums the components to fo.rm M2 r each of the components
should be studied separately. 4
No doubt the most dramatic velocity changes in· the post war period
are evident in the turnover series.
Demand deposit turnover calculated from
data for 233 clearing centers has risen more than six fold since 1950.
The
volume of debits to demand deposit accounts in these areas, which include
all large and medium siz~d cities and towns in the United States, has risen
almost twenty times -- or three times faster than.GNP.
A representative
dollar in a demand deposit account was being withdrawn about once every
ten business days in 1950; it was being withdrawn in less than two business
days in 1977. 5
The data exclude debits to and balances of interbank
deposit accounts.
Nevertheless, the turnover rate for all commercial bank
demand deposits is slightly overstated by the reported statistics which are
based on a disproportionately large number of large banks.
There is no
reason, however, to doubt the accuracy of the rates of increase of turnover.
It is notable that both bank debits and deposit turnover experienced
large jumps between 1972 and 1974 when this country experienced large
increases in its GNP price deflater (col. 9), and rather ominous to note
4specifically she rejected the hypothesis of functional separability
which is a necessary and sufficient condition for consistent aggregation.
5Associated with this growing rate of turnover is growing reliance on
wire transfers of funds relative to transfers effected by writing checks.
While data are contaminated by the presence of interbank transfers, the
pattern can be readily discerned from data published in annual reports of
the Federal Reserve Bank of Chicago. In 1961, 192 and 334 billion dollars
were respectively cleared hy the Chicago Bank through checks and wire
transfers. The corresponding numbers in 1977 were 906 and 7100 billion
dollars. Numbers of items cleared shows a similar pattern.
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Federal Reserve Bank of St. Louis
64
the further large increases that began to occur in the second half of
1976,
No coincident spurts in year-end levels of Ml or M2 are evident;
the action was in turnover.
Turnover can be affected by growth in the
volume of repurchase agreements, since overnight transactions do necessitate
debits to a corporation's demand deposit account.
It can be seen in Table
2 that large increases in net funds purchased were accompanied by jumps in
debits and deposit turnover.
III.
Interest Rates and Their Interpretation
The preceding sections have attempted to illustrate that a great deal
can be learned by carefully studying movements in monetary aggregates and
their velocities.
In this section, interest rates are compared in order to
draw additional inferences about events in the economy since 1965.
Table
3 reports quarterly series for nine prominent money market interest rates.
I wish to call your attention to six features of the table.
First, the basic interest rate or "shadow price" for funds at
commercial banks is the Federal funds rate.
When banks are under pressure
this rate rises relative to rates on other short-term assets which are more
broadly held, such as 90-day Treasury bills.
Using the arbitrary criterion
that if the two interest rates differ by as much as one percent policy is
active, the first two columns indicate that monetary policy was contractionary
between 1969:2 and 1970:1 and between 1973:1 and 1974:4, but not
active at other times.
liowever at the end of 1977 and in early 1978 the
gap between the two rate.a again seems to be widening which suggests that
policy is growing more stringent.
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Federal Reserve Bank of St. Louis
65
TAHI.E -,
RECENT HI STORY Of INTEREST ~ATES
(1)
(2)
Last Month
Federal
Market
Yield
(3)
4-6 Month
Prime
in Quarter
Funds
90 day
bills
Paper
3- 93
3.80
3-92
4. 38
4. 38
4. 38
4. 38
4. 65
4. 50
4. 50
4. 50
5. 00
4. 59
4. 50
5. 21
5. 51
5. 37
5.89
Com.
(4)
Prime
Interest
Rate
(5)
(6)
Moody's
Long
Term
Bonds
Corporate
u. S.Govt.
(7)
FHLHB
(8)
Moody's
(9)
Moody's
State
Aaa
Effec- Cartive
poratc
Rate
Baa
4.15
4.14
4. 25
4. 43
4. 42
4.46
4.52
4. 68
5. 81
5. 80
5. 79
5. 85
4. 78
4. 85
4. 91
5. 02
3. 09
3.15
3. 25
3. 39
4. 63
4. 63
4. 79
4. 65
4. 92
5.07
5. 49
5. 39
5. 98
6. 20
6.43
6. 58
5. 32
5. 58
6. 09
6. 18
3. 55
3. 60
3. 93
3. 79
& Local
J\aa
1965:
1
2
3
4
4.04
4.04
4. 01
4. 32
1966:
1
2
3
4
4. 65
5.17
5.40
5. 40
4. 96
6. 00
5. 50
5. 75
6.00
6.00
1967:
1
2
3
4
4. 53
3. 98
4. 00
4. 51
4. 26
3. 54
4.42
4. 97
5.24
4. 65
5.00
5. 56
5. 50
5.50
5.50
6.00
4.45
4. 86
4-99
5. 36
5.13
5.44
5. 65
6.19
6. 47
6. 35
6.44
6. 54
5. 85
6. 15
6.40
6. 93
). 47
3.80
3. 81
4. 15
1968:
1
2
3
4
5.05
6. 07
5. 78
6. 02
5.17
5. 52
5-19
5-96
5.64
6. 25
6.17
6.00
6. 50
6. 13
6. 75
5. 39
5. 23
5. 09
5- 65
6.11
6. 28
5. 97
6.45
6. 64
7. 03
7. 24
7. 23
6.85
7. 07
6. 79
7. 23
4. 28
4. 21
4. 23
4. 50
1
2
3
4
6. 79
8, 90
9.15
8. 97
6.02
6-44
7, 09
7. 82
6.82
8. 23
8.48
8,84
1, 50
8. 50
8. 5o
8. 50
6.05
6.06
6.32
6.81
6. 85
6. 98
7 .14
7. 72
7.47
7. 76
8. 05
8. 25
7. 51
7. 70
8.05
8. 65
4. 97
5. 58
5.83
6. 50
l
2
3
4
7. 76
7. 60
6. 29
4. 90
6. 63
6. 68
6.13
4.87
8.33
8.21
7. 32
5. 73
8.00
8.oo
7. 50
6. 75
6. 39
6. 99
6. 63
5. 97
7 .84
8.48
8.09
7. 64
8.47
8. 48
8.48
8. 38
8. 6)
9. 25
9. 39
9. 12
5.81
6. 81
5. 90
5. 21
3- 71
4. 91
5. 55
4.14
3. 38
4. 75
4. 69
4. 01
4.19
5.45
5. 75
4. 74
5. 25
5.50
6. 00
5.25
5. 71
5. 94
5. 56
5. 62
7 .21
7. 64
7 .44
7. 25
7. 66
7. 50
7.83
7. 77
s. ,. 6
8. 75
8. 59
8. 38
5. 00
5. 65
5.09
4. 99
1969:
1970:
1971:
5. 82
1972:
l
2
3
4
3. 83
4. 46
4.87
5. 33
3- 73
3- 91
4. 66
5. 07
4.17
4.64
5,14
5. 45
4. 75
5.25
5. 50
6.00
5. 66
5. 59
5. 70
5. 63
7 .24
7. 23_
7. 22
7 .OB
7. 52
7. 55
7. 57
7 .66
8. 24
8. 20
8. 09
7.9)
4-99
5. 07
5.12
4. 91
1973:
1
2
3
4
7. 09
8. 49
10. 78
9. 95
6. 09
7 .19
8. 29
7. 45
6.85
7. 99
10.23
9.08
6. 50
7. 75
10.00
9. 75
6. 20
6. 32
6.42
6.35
7. 29
7. 37
7. 63
7. 68
7. 68
7. 79
8.17
8.49
8.03
8. 13
8. 63
8.48
5. 07
5- 05
4. 90
4. 90
1974:
9. )5
11.93
11. 34
8. 53
7-96
7. 90
8. 06
7 .15
8. 42
10. 96
11.23
8. 98
9. 25
11.75
12. 00
10. 50
6.81
7. 03
7. 30
6. 78
8. 01
8.47
9. 24
8.89
8. 64
8.85
9. 19
9. 37
8.65
9-34
10.12
10. 55
5. 20
5. 95
6. 49
6. 65
1975:
5. 54
5. 55
6. 24
5- 20
5.49
5. 34
6. 42
5. 44
6.06
5. 79
6.86
5. 97
7. 50
7.00
8.00
7. 25
6. 73
6.86
7. 29
7 .17
8. 67
8. 77
8. 95
8. 79
9. 06
8.96
8. 94
9. 01
JO. 29
10. 40
10. 38
JO. 35
6. 28
4.84
5.48
5. 25
4. 65
5. 00
s.41
5. 08
4. 35
5. 37
5. 94
5.45
4. 70
6. 75
7. 25
7. 00
6. 25
6. 87
6.92
6. 70
6. 39
8. 52
8.62
8. )8
7. 98
8. 93
8.89
9.08
9. 10
9.
9.
9.
9.
99
72
10
12
s. 99
s. 85
s. 40
5. 07
4. 69
5. 39
6. 14
6. 56
4. 60
5. 02
5. 81
6. 07
4. 87
5. 49
6.17
6. 64
6.
6.
7.
7.
7. 20
6. 99
6. 94
7. 23
8. 10
7. 95
7. 92
8.19
8. 95
8. 98
9- 04
9. OB
9. 12
8. 91
8. 80
8. 99
5. 21
5.21
5. 27
5. 07
1976:
1977:
1
2
3
4
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Federal Reserve Bank of St. Louis
25
75
25
75
6. 28
6. 70
6. 50
66
Second, the prime commercial paper rate tends to move very closely
with the Federal funds rate, especially once allowance is made for the
longer maturity of commercial paper.
Commercial paper is the basic rate
among the lowest risk nonbanking institutions.
Traditiot111lly that rate
has moved closely with the prime loan interest rate.
Only twice before
1974:4 did these two interest rates differ by as much as 1%.
However
beginning in 1974:4 the two rates have always differed by at least 1%.
Evidently a basic structural change has occurred in the market for loans
to "prime" borrowers; borrowers who do not have access to the commercial
paper market are paying about 1% more than previously, relative to commercial
paper borrowers.
This is disturbing to me since many commercial and
industrial loans to a broad spectrum of firms are tied to the prime loan
rate.
It is no secret that 1) plant and equipment expenditures have been
very weak in the current recovery and 2) commercial bank loans at large
money center banks have not kept up with lending at other banks.
It is
surely worth investigating whether the prime loan rate has been maintained
at an artificially high rate -- a situation that would account for both of
the foregoing facts.
Third, a comparison of columns 5 and 6 shows a similar change in the
structure of financial market interest rates that is unfavorable to Aaa
rated quality corporate borrowers in the bond market.
Before 1970 in
only one quarter did thP gap between United States Government long-term
bonds and the Aaa rate amount to as much as one percentage point.
In every
quarter between 1970:1 and 1976:4 the gap was at least this wide, and the
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Federal Reserve Bank of St. Louis
67
gap was only trivially less than 1% throughout 1977.
Apparently the
market's evaluation of top quality corporate bonds was revised downwards
relative to government issues, perhaps because of 1) massive corporate
bond flotations that began with the crunch of 1969 or 2) the greater
incidence of call options in new debt issues.
For whatever reason, the
effect was to increase considerably the cost of raising funds in the bond
market and to discourage new plant and equipment expenditures by corporations.
Between 1965 and 1976 the increase in the cost of debt issues by
corporations was 40-50% greater than the increase for the Federal government,
a fact that was in no small way abetted by the extremely high interest rates
that the Federal Reserve permitted to exist in 1969, 1973, and 1974.
Fourth, although the picture is much muddied by the effects of revenue
sharing, a similar and even more extreme effect of rising interest rates is
evident in column 9, which concerns Aaa rated state and local government
securities.
For exampl", between 1965 and 1970 the interest rates on
these securities nearly doubled.
The probable explanation for this is
that, as interest rates rise, investors' demand for these securities is
likely to fall because
.1
smaller number of securities will suffice to
generate the relatively fixed amount of tax exempt income that is desired
by certain institutional investors.
The supply of new issues began to
slacken after revenue sharing was enacted and after taxpayer antipathy
to bonded indebtedness began to grow during the 1970's.
As a result, by
the end of the period interest rates facing the highest rated issues had
not risen proportionately with other market interest rates.
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Federal Reserve Bank of St. Louis
68
Fifth, a comparison of columns 7 and 8 suggests that Federal programs
to support housing and to hold down mortgage interest rates have had a
profound impact on the relation between the cost of borrowing by Baa rated
corporate borrowers and that of households acquiring mortgage loans,
programs began to emerge after the crunch of 1966.
The
At the end of 1967
Baa interest rates briefly rose above mortgage rates.
Beginning with the
1969 crunch, the corporate rates were almost always above the effective
mortgage interest rate quoted by the Federal Home Loan Bank Board.
It is
no coincidence that the Feder;.i National Mortgage Association was actively
expanding its mortgage portfolio during this period.
It is truly remark-
able that the greatest house building years by far, 1972 and 1973, only
drove the conventional mortgage rate trivially above the interest rate that
highly reputable private sector corporations could borrow at.
Through
housing programs Congress and the Johnson and Nixon administrations caused
capital market funds to be diverted away from corporations and towards
residential construction.
Partly as a consequence, capncity ltnits were
reached in several industrial sectors.
The rate of real nonresidential
fixed investment reached a peak in 1973 which it has yet to surpass.
The
only large major domestic sector implicit price deflater to show double
digit inflation between 1972 and 1973 was residential construction.
Between
1970 and 1977 the same deflater rose more than the deflater on any other
domestic sector in the GNP accounts,
In the four quarters ending 1977:4
the construction deflator was again rising at a double digit rate,
Begin-
ning in 1977:2, the effective mortgage rate finally fell below the Baa rate,
but at year end the Baa rate was rising much faster than the mortgage rate.
By today the mortgage rate is probably again lower.
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Federal Reserve Bank of St. Louis
69
Sixth, to further reinforce this interpretation, compare columns 6
and 7 in Table 3.
The interest rate gap between the highest rated cor-
porations and a representative home buyer has been substantially diminished
by government largesse.
Only once before 1967:2 had the differential
between the two rates been a s ~ as one percent.
Since that quarter
only once until 1976:4 has the differential been as much as one percent,
and in four quarters the representative home buyer could buy a house at
a lower interest rate than the most credit-worthy corporations in the land.
I am no dyed in the wool defender of large corporations, but I do believe
that housing and monetary policies in this country have severely increased
the costs of borrowing by corporations and have impaired capital formation
in manufacturing.
Corporations will only be willing to borrow at existing
high interest rates if they expect inflation to continue, since only then
can they expect to earn a positive rate of return on their investments.
Indeed, it is very likely that,corporations will need to have either a higher
future expected rate of inflation'?r lower market interest rates in order
to be attracted into the bond market these days because the rate of return
they earn on their plant and equipment investment is almost surely low
and falling relative to the previous 25 years.
IV.
Policy
From the preceding section it is evident that programs which subsidize
or assist sectors of the economy also have major effects on interest rates
in capital markets.
Monetary policy can have very different impacts on the
economy when different programs are in operation, whether gauged by the
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Federal Reserve Bank of St. Louis
70
course of some monetary aggregate or some interest rate.
Technical and
institutional changes described in the first two sections make the measurement and interpretation of monetary aggregates much more difficult today
than in the past (and it was never easy then!).
A modest conclusion is
that this Committee and the Federal Reserve should greatly reduce the
weight they place on movements in conventional monetary aggregates when
attempting to assess and formulate monetary policy.
The conventional
measures exclude quantities such as NOW accounts and funds acquired through
repurchase agreements that are operationally indistinguishable from money
for purposes of executing transactions, and that are growing rapidly and
unevenly.
These excluded quantities obviously affect the relation between
economic activity and conventional monetary aggregates.
Monetary aggregates do cause excitement on Thursday afternoons when
weekly figures are announced, primarily (probably solely!) because they
give investors a cue about what the Federal Reserve is likely to do in the
coming weeks that will affect interest~•
The Federal Reserve would
help its own cause by renouncing any intention of adhering inflexibly to
its target growth paths.
Its preoccupation with aggregates provides an
incentive for banks and others in the private sector to invent money
substitutes -- not that they really require such incentives.
Interest rates are not perfect touchstones for ev:1luattng monetary policy
either.
However, many of them are measured accurately and they do convey a
picture of what is happening in different sectors of the economy.
They are
treacherous because a given level of interest rates may be too high or too
low depending upon what rate of inflation is expected in some sectors or in
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Federal Reserve Bank of St. Louis
71
the economy at large.
They should be consulted more than they presently
are when evaluating monetary policy -- but cautiously,
Since information about both conventional monetary aggregates and
interest rates conveys an incomplete picture about the conduct of monetary
policy, additional information is desirable.
Very little published infor-
mation is available about the volume of Federal funds thst the banking
system purchases from institutions that are not commercial banks or about
the volwne of funds raised bf banks through repurchase agreement transactions.
Also, very little information is currently available about the extent to
which balances at foreign branches of domestic banks are owing to domestic
corporations or their foreign subsidiaries.
is not reported for the country at large.
The volume of wire transfers
These data should be collected
and reported if one hopes to interpret monetary aggregates even partially.
The Federal Reserve, of course, has additional information at its disposal
which helps the Federal Open Market Committee (FOMC) to reach policy
decisions.
If -the performance of the central bank is to be fairly appraised,
this information and its interpretation in FOMC meetings should be released
promptly, as soon as tactical considerations in the money market permit,
but surely with a lag of no longer than a year.
I believe that complete
minutes of FOMC meetings should be made public after a lapse of one year.
While such information is not available to me, I would like to comment
briefly on the Federal Reserve's continuing and apparently losing battle
with inflation.
Between 1971 and 1977 the Federal Reserve succeeded in
having both member bank reserves and Ml grow at a slower rate than the GNP
price deflater (see Table 2) so that their real, constant dollar counter-
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Federal Reserve Bank of St. Louis
72
parts actually declined o~er a period in which real GNP was growing.
Many interest rates reached 100 year highs in 1973 and 1974, and restrictive
monetary policy played a major role in precipitating the sharpest economic
decline in forty years.
Long-term United States government interest rates
appear to have reached a plateau in the neighborhood of 7% which has continued for about four years.
Quite frankly I am very doubtful that the
Federal Reserve has the tools to reduce the rate of inflation appreciably
without inflicting unacceptable damage on capital market institutions and
the level of economic activity.
This pessimistic view stems from four
considerations.
First, monetary tools are just like any other tools; with prolonged
use they wear out.
The money market has been remarkably innovative in
countering restrictive monetary policy and in exploiting the high interest
rates that accompanied it.
The first two sections contain some examples
of innovations, but do not stress the ingenious use of the bank holding
company corporate form and the innovations implicit in evolving electronics
fund transfer systems.
When interest rates get high it pays to innovate
and the Federal Reserve may not be able to do much more than stay even
with the innovators.
Second, inflation is often a consequence of disequilibria in markets
where individuals tend to adjust to shocks eith,,r by raising prices or by
holding them constant as the case may be.
It apparently is a matter of
sociology that individu~ls are not happy walking away from negotiating
sessions if they must accept a nominal wage or price~-
In the last
decade this country has faced an unusual sequence of large shocks, some
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Federal Reserve Bank of St. Louis
73
of its own making, that resulted in large upward price and wage adjustments.
For the most part these shocks were beyond the control of the Federal
Reserve, and they continue to occur.
Third, there is at least one hideous example of what can happen if
the Federal Reserve were to succeed in reducing the rate of inflation
precipitously through restrictive high interest rate policies.
Between
1926 and 1929 the inflation rate was becoming increasingly negative; a
debacle resulted when the Federal Reserve unconscionably drove up interest
rates in 1928 and 1929.
On several occasions since 1969 the Federal Reserve
has rattled the China in the capital market cupboard with high interest
rates as corporations, cities, and large banks failed or just escaped
insolvency.
It is a tribute to the skill of the Federal Reserve that
these crises were contained, but one could get unlucky.
Fourth, the origins of the current inflation are at least as much
in bad fiscal policy as they are in bad monetary policy.
The Federal
Reserve's anti-inflationary stance can easily be frustrated by other
elements in the government.
Table 4 reports information about six impor-
tant debt measures over the last thirty years.
All sectors of the private
economy have been incurring large debts in the post-war period as should
be the case in any healthy economy.
Until 1965 the Federal government had
been exceedingly responsible; neither it nor its agencies had increased
the outstanding public debt appreciably.
This pattern changed greatly in
the Vietnam era for reasons that are well known.
Between 1971 and 1976
the Vietnam era pattern persisted and full faith and credit debt (FFCD)
of the Federal government rose almost as rapidly as GNP.
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Federal Reserve Bank of St. Louis
Debt of agencies
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Federal Reserve Bank of St. Louis
Table 4
DEBT AND INCOME SINCE 1945
(l)
GNP
(2)
Federal
Debt
(3)
Agencya
Debt
(4)
(5)
(6)
(7)
(8)
(9)
State & Local
Debt
Total
Private
Debt
Corporate
Debt
Mortgage
Debt
Federal
Debt
GNP
Federal
and Agency
Debt-a-GNP
1945
1950
1955
1960
1965
1970
212.3
286.2
399.3
506.0
688.l
982.4
252.5
217.4
229.6
239.8
266.4
301.1
0.7
2.9
3.5
8.9
38.8
13.4
21.7
41.l
64.9
98.3
144.8
140.0
246.4
392.2
566.l
878.9
1397.2
85.3
142.l
212.1
302.8
454.3
797.3
35.5
72.8
129.9
207.5
333.3
474.2
1.19
.76
.58
.47
.39
.31
1.19
.76
.58
.48
.40
.35
1971
1972
1973
1974
1975
1976
1063.4
1171.l
1306.6
1412.9
1528.8
1706.5
325.9
341. 2
349.l
360.8
446.3
515.8
39.9
41.4
59.8
76.4
78.8
81.4
162.7
178.0
192.3
211.2
222. 7
236.3
1538.8
1739.2
1961.l
2145.l
2281.0
2521. 5
871.3
975.3
1106.7
1223.0
1286.6
1414.7
526.5
603.4
682.3
742.5
801.5
889.l
.31
.29
.27
.26
.29
.30
.34
.33
.31
.31
. 34
.35
Source:
Economic ReEort of the President, 1978 1 EE· 268, 336-7.
Note:
Units in columns 2 through 7 are billions of dollars; units in column 1 are billions of
dollars/year; and units in columns 8 and 9 are years.
aAgency debt is debt of agencies in which there is no longer any Federal proprietary interest.
-...
~
75
more than doubled in these same years.
Agency debt is understandably a
close substitute for FFCD in the eyes of financial market traders; in effect,
they believe that the issuance of such debt is only a ruse to reduce the
apparent growth of the Federal debt.
In the private sector, only mortgage
debt rose conspicuously faster than GNP in the same years, in large part
because a significant fraction of mortgages were laundered through sponsored
agencies like Fl!MA.
In short, agencies and the Federal government have been flooding
financial markets with high quality paper and, as columns 8 and 9 in the
table indicate, the ratio of such paper to GNP has been rising rapidly in
recent years.
All the Federal Reserve can do is control the extent to
which this gusher is converted into high powered money, such as currency or
member bank reserves.
I do not wish to be misinterpreted to be saying that government
spending is too large.
Real Federal government expenditures on goods and
services are about of the same dollar magnitude as they were during the
years of the Kennedy administration; as a percentage of real GNP they have
declined from 12.9% in 1962 to about 7.6: in 1977.
Serious problems face
the country's urban areas, its environment, and its people that require
increased expenditures and tax revenues.
The government must make the
politically difficult decisions about who will pay for these programs and
not sweep them under some agency rug.
I wish to close this paper by making some suggestions for legislation
that may improve the condition of the economy.
I realize that some of them
are not in the jurisdiction of this Committee, but the problems being faced
are also not entirely within your jurisdiction:
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Federal Reserve Bank of St. Louis
76
1.
Impose reserve requirements on deposit balances that American
firms and their foreign subsidiaries carry with foreign branches of
American commercial banks.
This proposal presumes that issue a) at the
beginning of this paper is accepted.
There is no good reason why
American firms should be encouraged to keep their,balances abroad where
they add to the dollar overhang.
Why should reserve requirements only
impact on domestically held compensatory balances?
2.
Eliminate the deferring of income taxes on income realized by
foreign subsidiaries of American corporations.
Again, there is no good
reason why these firms should be encouraged to retain their earnings
abroad where they probably add to the dollar overhang.
Why should multi-
national firms benefit at the expense of their domestic rivals?
A strong
case can also be made for reducing the tax credit which multinational firms
take when they pay taxes to foreign governments, for similar reasons.
Why
should the United States serve as a remainderman?
J.
Legislation should be drawn up that severely limits the volume of
debt issues that agencies may have outstanding.
The reasons for this
proposal should be clear from the foregoing discussion.
4.
I support the administration's proposal to eliminate the exemption
which applies to interest on state and local government debt on Federal
income tax forms.
The reasons were provided in section 3 where it was noted
that municipal interest rates were abnormally volatile.
This proposal can
also, of course, be defended on efficiency grounds.
5.
I support imposing taxes to discourage the use of imported petroleum
products on the grounds that a continuation of the current devaluation of
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Federal Reserve Bank of St. Louis
77
the dollar will seriously increase the domestic inflation problem.
A one-
time rise in domestic oil prices is not likely to be as inflationary as a
continuing devaluation.
6.
I would like to see the growth rate of commercial banking system
assets held to about 8% on the grounds that bank profits are not keeping
pace with banking assets.
Elsewhere I [Hester, 1976] have argued extensively
that the ratio of capital to assets at commercial banks, especially large
commercial banks, is too low and should be increased.
Recent newspaper
reports indicate that ratios of net income to assets fell at nine out of the
ten largest bank holding companies in 1977 when compared to 1976.
Inci-
dentally, I continue to believe that many proposals from the FINE study merit
favorable consideration.
7.
Finally, I believe a case exists for imposing reserve requirements
on funds acquired from nonbanks through repurchase agreements.
be treated as demand deposits.
They should
Also, in the interest of full disclosure
commercial banks should be required to show separately on call reports the
volume of government securities that they have sold through repurchase
agreements.
t!adison, Wisconsin
28-083 0 - 78 - 6
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Federal Reserve Bank of St. Louis
April 10, 1978
78
Friedman, M. and A. J. Schw.srtz, 1970, >!onet:trv Statistics of the United
States, Studies in Business Cvcles No. 20, National Bureau of
EcoMmic Research, New York.·
Friedman, M., 1948, "A Monetary and Fiscal Framework for Economic Stability,"
American Economic Review, Vol. XXXVIII, No. 3, pp. 245-64.
Goldfeld, S. M., 1976, "The Case of the Missing Money," Brookings Papers
on Economic Activity, No. 3, pp. 683-730.
Hester, D. D., 1976, Opportunity and Responsibility in a Financial
Institution," Compendium of Papers Prepared for the FINE Study,
United States Government Printing Office, Washington, pp. 173-91,
Lombra, R, E, and H, M. Kaufman [undated), "Federal Funds and Short-Run
Commercial Bank Behavior," unpublished paper.
Little, J. S., 1975, Eurodollars:
Row, New York.
The Money Market Gypsies, Harper and
Simon, H., 1936, "Rules versus Authorities in Monetary Policy," Journal
of Political Economy, Vol. XLIV, No. 1, pp. 1-30,
United States House of Representatives, Committee on Banking, Currency
and Housing, 94th Congress, 1976, Financial Institutions and the
Nation's Economy, Compendium, U.S. Government Printing Office,
Washington.
Wood,
c. w., 1976, Nonbank Financial Intermediation and the Effectiveness
of Monetary Policy, unpublished doctoral dissertation, University
of Wisconsin.
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Federal Reserve Bank of St. Louis
79
Senator RIEGLE [presiding]. Thank you very much. I know it is
difficult to try to summarize such complicated information and observations in such a short time. We appreciate your efforts. We
certainly are going to make your full statement a part of the record,
and I am confident we will have a chance to discuss it soon and give
you a chance to elaborate on some of these things.
Dr. Thomson, let me welcome you before the committee with the
same sense of home state pride .that Senator Proxmire had with
Dr. Hester. I have the same feeling toward you and am especially
pleased we are having someone here who not only is a top professional
in the field, but has a MBA from a Big Ten university, which is
certainly not a minus when you are dealing with either Senator
Proxmire or myself. I don't know if Senator Lugar has one, but we
may give him an honorary one before the year is out.
In any event, we are pleased to have you here speaking on these
issues, representing not only your own opinion, but the Detroit Bank
and Trust Co. Let's try to stay within the same format, if you can,
give us an overall summary, and then we will get into detail later.
STATEMENT OF THOMAS D. THOMSON, FIRST VICE PRESIDENT AND
CHIEF ECONOMIST, DETROIT BANK AND TRUST CO.
Dr. THOMSON. Thank you very much, Senator. I am honored to have
this opportunity to talk to this committee. I will give a brief summary of my testimony, and highlight those points which I think are
the most important.
We are all aware that the economy was at a standstill during the
most recent quarter. Although economic activity will rebound from
the depressed first quarter, growth in the latter part of 1978 is likely
to remain quite moderate. Let's review the current situation in some
detail before discussing what I consider to be the more relevant
longer term issues.
As I say in the statement, 1978 has been programed by past events
and the direction of current policy will have only a minimum effect
until 1979 or 1980. The growth of real GNP is likely to be 6 or even
7 percent this quarter, which will represent a first-half growth rate
between 3 and 4 percent-a fairly mediocre performance and one
that will not lead to significant declines in the current rate of unemployment. It is unlikely that economic activity will accelerate
a-ppreciably during the second half. Economic growth for the year of
about 4 percent can be expected, thus a significant gap between actual
and potential output will remain. Even in this kind of environment,
inflationary pressures are likely to remain disgustingly high.
I might summarize the situation by saying that although the consumer has led this recovery, consumer well being is not presently
showing healthy signs. The have reduced their savings rate below
that rate which they presumably desire. The ratio of consumer debt
to income is currently very near its all-time high. If we look at the
economy sector by sector, and try to forecast a better economy than
most of the forecasts you have heard this morning, it becomes a very
hard task. The sectors which can be conceived of doing significantly
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Federal Reserve Bank of St. Louis
80
better are scant. Just to take a few key sectors, autos, for example,
will not reach a sales level of last year's 11.2 million units. The last
6 weeks of auto sales have been very good, however. Housing starts,
another example, will do well to match last year's 2 million units.
Senator RIEGLE. Let me ask you, when someone like Tom Murphy
of General Motors continues to make very bullish forecasts on auto
sales, which runs counter to the suggestion you have just made, do
you as a professional, being based in Detroit, tend to write that off as
kind of standard optimism, positiveness that the auto industry tends
to promote as a way of sort of trying to create a more positive pyschology, or do you think he really believes that and you and he just
disagree on this point?
Dr. THOMSON. 0£ course, it is impossible to tell what anyone really
believes. I do think the forecast he is still espousing is far too
optimistic. I£ you look in the past record of chief executives in forecasting auto sales has been pretty bad. I think it is a natural human
tendency to be optimistic at the beginning of the year. There has
always been an error in that direction. I suppose if one were a
pessimist, it would feed back on sales. So I think that to indicate that
we are going to have a record year right now is on the far side of
optimism.
I don't want to appear to be very gloomy on the economy since it
is still void of any serious excesses. Despite inflationary £ears, businessfirms have not been buying in anticipation of future price rises.
Credit demands, although fairly vigorous, are not expected to reach
crunch proportions this year. We are probably in a period somewhat
similar to late 1976 when the well-publicized consumer "pause" took
place. Given the unfortunate economic experiences in the middle part
of this decade, businesses and consumers are very £earful of an
overheated economy. Moderate pauses serve to partially alleviate
these fears. If we continue to have these periodic and brief sideway
movements, we may be able to avoid an overheated economy and
subsequent recession £or many more quarters.
Turning to monetary policy, I find it hard to quarrel with the
policies executed in 1977. During most of the year money was clearly
growing at a rate £aster than that consistent with longer term price
stability. The Federal Reserve had to respond, even though a 200
basis point rise is hard medicine for money markets and the economy.
Indeed, the recent revisions in the money supply data indicate that
an earlier, more vigorous response might have been appropriate. Had
they not responded, the effect on current inflationary expectations
and future actual inflation would have been very harmful. The
Federal Reserve was counseled by many that they were aborting the
housing recovery and taking too much edge off the economic expansion. The reduction of the rate of inflation, however, appropriately
remained a high priority of monetary policy.
I would, however, quarrel with the quarter-point rise in the Federal
funds rate in early ,January 1978. This was clearly not needed for
purposes of domestic monetary control. It was prompted by a wish
to support the dollar even though U.S. domestic interest rates were
very competitive with those in most industrialized countries. Domestic
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Federal Reserve Bank of St. Louis
81
money market participants were already expecting very large increases in short-term interest rates later in the year and the surprise
discount and Federal :funds rate change confirmed their worst fears.
The price of intermediate and longer term Government and corporate bonds fell sharply and the Dow Jones stock averages dropped
another 50 points. It is hard to make the case that the value of the
U.S. dollar is presently any higher than it would have been in the
absence of a tightening in policy.
My statement was written before this past Wednesday, and I
would naturally be critical of the latest move toward tightening
which brought the Federal funds target up to 7 percent. This is
simply not needed. Indeed, it is dangerous for the economic health
o:f the country especially for the period between mid-1978 and mid1979.
Since January the growth of the monetary aggregates has been
quite slow. 'i'he level of M 1 balances, for example, were about the
same at the end of March as they were at the end of January. Markets
became exuberant week before last when the expected early April
blip in the money supply failed to materialize. The slowing of this
growth rate is not just a random movement in a very volatile series.
It has two primary causes. First, and most important, is the endogeneous nature of money in the short run. The primary function o:f
Money, M 1 , is to facilitate transactions. Transactions obviously have
not grown much during the last few months. This is not to imply that
money reacts solely to current transactions. Since people adjust their
transaction needs rather slowly, it is also a function of past economic
activity.
If we use nominal GNP to measure the change in transaction
demand, we see that GNP has slowed from a 13-percent rate of increase in the first hal:f of 1977 to about a 10-percent change in the
last half. Since the rate of GNP growth slid even further in the first
quarter of 1978, it is no wonder that money has been behaving
during recent months. Current money growth is slowly because economic activity has been slowing for almost 1 year.
The second reason :for the recent slowing in money growth is the
lagged effect of the 200 basis point rise in short-term interest rates
in 1977. The assumption of money market participants, especially the
Federal Reserve, seems to be that a quarter point change in the Federal funds rate does wonders in that quarter in which the change is
made. In every piece of quantitative work of which I am aware, the
first quarter effect of an interest rate change is very small. Money
reacts very slowly to interest rates. The biggest effect of an interest
rate change comes two or three quarters hence. Thus, in 1978, we are
seeing the result of 1977 interest rates. It is in the context of these
lags that recent tightening appears inappropriate.
Based on my analysis of the economy and the nature of the money
supply, I see money growth averaging about 6 percent :for the remainder of this year without a further rise in the Federal funds rate.
There is a good chance, however, that as the economy accelerates from
the depressed first quarter, money growth will appear to be on a
path somewhat faster than this. Nominal GNP growth o:f 13 or 14
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Federal Reserve Bank of St. Louis
82
percent is likely this quarter and money demand may well move in
partial sympathy to this acceleration. It would be a mistake, however, for the Fed to raise interest rates in response to a temporary
resurgence in monetary growth. That growth would be an accident
of the nature of the winter and not the beginning of several quarters
of high economic and monetary growth. The chance of having two
successive quarters of 13 or 14 percent nominal GNP growth, as we
experienced in the first two quarters of 1977, seems very remote.
Thank you.
[The complete statement of Dr. Thomson follows:]
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Federal Reserve Bank of St. Louis
83
Statement by Thomas D. Thomson
First Vice President and Chief Economist
Detroit Bank and Trust
Before the Committee on Banking, Housing, and Urban Affairs,
U.S. Senate
April 24, 1978
Mr. Chairman, I am honored to have this opportunity to express my views to this
committee.
This seems to me to be a very crucial time in the conduct of both
monetary and fiscal policy.
We are all aware that the economy was in a virtual
standstill during the moat recent quarter.
Although economic activity will rebound
from the depressed first quarter, growth in the latter part of 1978 is likely to
remain quite moderate.
Let us review the current situation in some detail before
discussing what I consider to be the more relevant longer term issues.
As I
will elaborate in the latter part of my testimony, 1978 has been programmed by
past events and the direction of current policy will have only a minimum effect
until 1979 and 1980.
The growth of real GNP is likely to be six or even seven percent this quarter,
which will represent a first half growth rate between three and four percent -a fairly mediocre performance and one that will not lead to significant declines
in the current rate of unemployment.
It is unlikely that economic activity will
accelerate appreciably during the second half.
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Federal Reserve Bank of St. Louis
Economic growth for the year
84
of about four percent can be expected, thus a significant gap between actual and
potential output will remain.
Even in this kind of environment, inflationary
pressures are likely to remain disgustingly high.
As has often been repeated, the consumer has lead this recovery.
This has been
financed by reducing the saving rate below that level probably desired by the
consumer.
The average ratio of saving to income has averaged about 6.3 percent
since 1960 but fell to slightly over five percent last year.
The present very
high ratio of constDDer debt to income is another indication of the strained nature
of consumer finances.
In short, consumers may show signs of exhaustion at a time
when business investment is having less than a normal cyclical upswing.
If one
sets out to build an economic forecast of a more buoyant economy, it is difficult
to find the sectors that will provide the strength.
Housing starts, for example,
cannot be expected to exceed last year•s almost two million units.
There are few
optimists (even in Detroit) who see auto sales able to exceed last year's 11.2
million domestic and imported cars,
In 1977, the constuner increased purchases
of real durables other than autos by a very strong 7,3 percent,
of nondurables ended 1977 at an exceptionally strong pace.
Even purchases
These acts are hard
to follow,
I do not want to appear to be reciting a litany of travail and gloom,
economy is still void of any real excesses,
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Federal Reserve Bank of St. Louis
The
Despite inflationary fears, business
85
firms have not been buying in anticipation of future price rises.
Credit demands,
although fairly vigorous, are not expected to reach "crunch" proportions this
year,
We are probably in a period somewhat similar to late 1976 when the well
publicized consumer "pause" took place.
Given the unfortunate economic experiences
in the middle part of this decade, businesses and consumers are very fearful of
an overheated economy.
Moderate pauses serve to partially alleviate these fears.
If we continue to have these periodic and brief sideway movements we may be able
to avoid an overheated economy and subsequent recession for many more quarters.
Within the context of this general outlook, I would like to review current policy,
I find it hard to quarrel with policy as it was executed in 1977,
During most
of the year, money was clearly growing at a rate faster than that consistent with
longer term price stability,
The Federal Reserve had to respond even though a 200
basis point rise in short-term rates is hard medicine for money rnarkets and the
economy.
Indeed, the recent revisions in the money supply data indicate that an
even earlier, more vigorous response might have been appropriate.
Had they not
responded, the effect on current inflationary expectations and future actual
inflation would have been very harmful.
The Federal Reserve was coW1seled by
many that they were aborting the housing recovery and taking too much edge off
the economic expansion.
The reduction of the rate of inflation, however,
appropriately remained a high priority of monetary policy,
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Federal Reserve Bank of St. Louis
86
I would, however, quarrel with the quarter point rise in the Federal funds rate
in early January 1978,
monetary control,
This was clearly not needed for purposes of domestic
It was prompted by a wish to support the dollar even though
U.S. domestic interest rates were very competitive with those in most industrialized
countries.
Domestic money market participants were already expecting very large
increases in short-term interest rates later in the year and the surprise discount
and Federal funds rate change confirmed their worst fears.
The price of intermediate
and longer term Government and corporate bonds fell sharply and the Dow Jones stock
averages dropped another fifty points,
It is hard to make the case that the value
of the U,S, dollar is presently any higher than it would have been in the absence
of a tightening in policy,
Since January the growth of the monetary aggregates has been quite slow,
The
level of Ml balances, for example, were about the same at the end of March as
they were at the end of January,
Markets became exuberant last week when the
expected early April blip in the money supply failed to materialize,
The slowing
of this growth rate is not just a random movement in a very volatile series,
It
has two primary causes.
First, and most important, is the endogenous nature of
money in the short run,
The primary function of money (Ml) is to facilitate
transactions,
months,
Transactions obviously have not grown much during the last few
This is not to imply that money reacts solely to current transactions.
Since people adjust their transaction needs rather slowly it is also a function
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Federal Reserve Bank of St. Louis
87
of past economic activity.
If we use nominal GNP to measure the change in
transaction demand, we see that GNP has slowed from a 13 percent rate of increase
in the first half of 1977 to about a ten percent change in the last half.
Since
the rate of GNP growth slid even further in the first quarter of 1978, it is no
wonder that money has been behaving during recent months.
Current money growth
is slowing because economic activity has been slowing for almost a year.
The second reason for the recent slowing in money growth is the lagged effect
of the 200 basis point rise in short-term interest rates in 1977.
The assumption
of money msrket participants, especially the Federal Reserve, seems to be that
a quarter point change in the Federal funds rate does wonders in the quarter in
which the change is msde.
In every piece of quantitative work of which I am
aware, the first quarter effect of an interest rate change is very small.
reacts very slowly to interest rates.
The biggest effect of an interest rate
change comes two or three quarters hence.
result of 1977 interest rates.
Money
Thus in 1978, we are seeing the
It is in the context of these lags that the
early 1978 tightening appears inappropriate.
Based on my analysis of the economy and the nature of the money supply, I see
money growth averaging about six percept for the remainder of this year without
a further rise in the Federal funds rate.
There is a good chance, however, that
as the economy accelerates from the depressed first quarter, money growth will
appear to be on a path somewhat faster than this.
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Federal Reserve Bank of St. Louis
Nominal GNP growth of 13 or
88
14 percent is likely this quarter and money demand may well move in partial
sympathy to this acceleration.
It would be a mistake, however, for the Fed to
raise interest rates in response to a temporary resurgence in monetary growth.
That growth would be an accident of the nature of the winter and not the beginning
of several quarters of high economic and monetary growth.
The chance of having
two successive quarters of 13 or 14 percent nominal GNP g~owth, as we experienced
in the first two quarters of 1977, seems very remote.
Given the picture of fairly modest economic growth that has been presented, the
question of an ease in policy could well be raised.
appropriate during the last half of 1978.
Perhaps some easing will be
The degree should be modest, however
since a significant easing might add too much stimulus to next year's economy.
It is likely that after a "pause" in 1978, the economy next year will be ready
for a somewhat stronger advance.
It seems even more certain that inflation will
still be our largest economic problem.
By 1979 we will be in our fifth year of
economic growth and our human and other capital resources will have less slack.
In such an environment, inflation will not drop below the five to seven percent
range and indeed may very well worsen.
We are far enough into the planning process for fiscal 1979 to know that the
Federal deficit will be very large given the advanced stage of the business
cycle.
It would be a major mistake to lay the groundwork this year for both
tools of policy, fiscal and monetary, to push the economy too hard in our current
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Federal Reserve Bank of St. Louis
89
inflationary environment,
Next year's deficit will have to be financed in
markets in which private credit demands will be increasing,
Too low a Federal
funds rate will increase the rate at which that debt is monetized.
Given the
delicate state of today's economy and the potential worsening of inflation,
prudent policy calls for a very steady hand this year,
Thus far I have made no specific comment whether the Federal Reserve should raise
or lower its monetary target ranges for the period ahead,
Rather than address that
narrower issue, I would like to comment on the present scheme of monetary targets
and congressional oversight.
The periodic trips to the Capitol by the Chairman
of the Board of Governors has some comic aspects.
Serious discussion takes place
concerning the appropriateness of a quarter or a half point change in the monetary
growth targets.
The money supply subsequently misses the target by degrees which
makes the previous discussion seem trivial.
Seldom is it recognized that monetary
growth during the subsequent quarter will be little affected by anything the
Federal Reserve will do even though their actions will have a powerful effect
several quarters hence.
The discussion proceeds as though the money creation
process were a precise mechanism with strong immediate linkages although in reality
it is a rather blunt instrument with long delays.
Given the nature of economic data and economic forecasting, the process for control
and oversight will always be difficult.
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Federal Reserve Bank of St. Louis
The present procedures, however, can be
90
greatly improved.
It is hard to understand how well meaning people can continue
the process of the "moveable base."
The growth rate targets are calculated using
the average of the previous quarter as the base from which growth is measured.
If money misses the target range, a new quarterly average is calculated and there
is no attempt to get t h e ~ of the money stock back on path.
This procedure
tends to impart a pro-cyclical bias to the monetary aggregates.
Since economic
activity from one quarter to the next tends to be correlated, we are likely to
see the base for calculation change in successive steps in the same direction.
During a period of accelerated activity, for example, money growth exceeds the
target.
This is forgiven and the growth ranges are again established.
The next
quarter also exhibits strong economic activity and monetary growth and the base
is again changed.
After several quarters, the level of the aggregate is far
above the target path of several quarters ago.
on this, however.
Not much attention is focused
The reverse process would take place during periods of slow
growth or during an economic downturn.
Successive misses would mean successive
changes in the rules of the game.
Another needed improvement in present procedures is the attainment of timely data
on deposits at banks which are not members of the Federal Reserve system.
The
recent upward revision of 1977' s Ml growth by almost a half percentage point well
illustrates this deficiency.
Banks and their regulatory agencies resist an
increase in reporting burden but the needs of policy should dominate.
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Federal Reserve Bank of St. Louis
The control
91
of money and currency is unambiguously the province of the Federal government
and accurate, timely, data is absolutely essential.
Although the appreciation of the importance of monetary policy has grown during
the past few years and our understanding and even the execution of policy has
probably improved, there is still a tendancy for money to be pro-cyclical.
In
the economically depressed years of 1974 and 1975, for example, money (Ml) grew
at a less than five percent rate.
grew 7.8 percent.
In the far more prosperous year of 1977, money
The primary reasons for this have already been mentioned in
this testimony but deserve further elaboration.
quarterly average.
One is the problem of the sliding
The most important reason, however, is the loose linkage
between short run changes in reserve availability or money market conditions and
current money growth.
simply not appreciated.
The pre-ordinated nature of short run money growth is
There are at least two possible conceptual remedies
to the current method of policy formation.
One solution would be to change money
market conditions by whatever degree necessary to achieve short run monetary
aggregate goals.
The effect of Federal Reserve actions in the current quarter
is not zero but very small.
The Manager of the Open Market Account could conceivably
achieve a given target if enough reserves were withdrawn or injected.
rate fluctuations would be far greater than they have been in the past.
Interest
If the
economy is very strong and the transaction demand for money is growing, a very
large rise in interest rates would be necessary.
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The Federal funds rate might
92
very well fluctuate ten points in a given quarter.
The movement of other interest rates would be slightly less volatile than the
fund's rate.
Treasury bill, commercial paper, and even intermediate and long-term
rates, however, would move considerably further and more often than they have
in the past.
This scheme, which can be described as a strict monetarist approach,
would result in strains upon the present institutional framework.
The economic
system could probably adapt but the transition to this system would create
considerable uncertainty.
The minimization of the importance of an economic
forecast would be viewed by many as its primary virtue.
The monetary screws are
turned hard enough to make money hit a particular target regardless of the demand
side of the money market,
The more powerful lagged effects might well have to
be undone in later quarters.
The monetary control system described above might work very well,
A less pro-cyclical
monetary growth would result and cycles in real economic activity might be
moderated.
Much more research and public policy discussion would have to be done
before it was advisable to move in this direction, however.
As a practical matter,
it seems unlikely that the Federal Reserve on its own or at the request of Congress
1• about to make dramatic changes of this type,
Public policy change is slow
but some change from the present system must evolve.
be along the following lines,
This development might well
The Federal Reserve should report what it expects
for monetary growth during the next two years as well as for the current quarter.
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They should make explicit the complete economic outlook upon which this projection
is made.
The Federal Reserve and the Congress should recognize that the near term
is a pure forecast.
The longer term, however, can be called a target or goal.
Various monetary policy tools may be used to achieve these objectives.
At the
present, for example, the Chairman might well report that monetary growth in the
second quarter of 1978 is expected to be more vigorous than last quarter but is
likely to mod~rate somewhat in the last half of this year.
He should go on to
describe the monetary policy actions that are needed this year to achieve the
economic goals of 1979 and 1980.
The public policy tradeoffs between, say,
inflation and employment in arriving at the policy strategy should be made explicit.
The Congress and the public would be able to comment upon the strategy.
Much more
useful debate could take place than the present system of commentary on monetary
growth targets that are often not achievable in the short run and will be ignored
in the process of reinitializing the base of calculation in any event.
In mid-1977 the Council of Economic Advisors set out a game plan for the ensuing
four years.
the numbers.
It was possible to evaluate the reasonableness and consistency of
The difficult policy questions were recognized.
There was an
awareness, for example, that the cost of a very rapid closure between potential
and actual GNP would be too great a sacrifice of the goal to reduce inflation.
A balanced budget was targeted for the early 'SO's.
goals were too ambitious.
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Many thought the implied
Many of us in the private sector are chagrined that
94
the goal of a balanced budget seems to have been an early casualty.
It was
possible, however, to know the thinking of the economic policy makers and offer
criticism.
As you are well aware, the Federal Reserve has never offered us as
much substance.
The Federal Reserve' s game plan should include all major economic variables in
the economy including, of course, Gross National Product, employment, inflation
and interest rates.
In the past, the Federal Reserve has been extremely reluctant
to give an indication of their interest rate expectations.
They feel that their
interest rate projection will immediately become the pervasive expectation in
the money market.
Because of these feedbacks, it is feared that the execution of
policy will be undermined since interest rates might rise or fall sooner than is
optimal from a policy viewpoint.
Few would argue, however, that the formulation
of fiscal policy in full view of the private economy renders fiscal policy
ineffective.
(There are some "rational expectationists" who do believe this.)
People will soon learn that the projections of even the Federal Reserve often go
awry.
Because of events independent of policy, targets and goals that appeared
consistent will have to be altered.
that they can accept as truth.
The private sector will not have an anchor
The public and the Congress will, however, gain
far better insights into the policy options and the implications of current policy.
The Federal Reserve's simultaneous willingness to discuss monetary aggregates and
reluctance to mention interest rates makes no economic sense.
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One cannot affect
95
money without affecting interest rates.
in the money market.
Interest rates are the price variable
Slowing down an overly expansive money supply will depend
upon raising the price of money.
Perhaps the basic reason the interest rate
implications of money targets are avoided by the Federal Reserve is the realization
that they would be creating additional political problems for themselves.
Congress has shown a rather consistent bias for low interest rates.
prefers low interest ra'tes.
tight money.
Almost everyone
Many groups are especially adversely affected by
The housing industry, including labor groups and housing related
financial institutions, realize that housing suffers in periods of high interest
rates.
These groups naturally get a hearing in Congress.
There are times,
however, when high interest rates are necessary to slow down the pace of the
economy.
This last statement can be agreed with conceptually but in practice
the public feels the time is never quite right for an increase in monetary stringency.
Although in today's environment I too find no need for a policy induced rise in
interest rates, there is little doubt that within the next couple of years, interest
rates will have to rise considerably.
For the past three years, short-term interest
rates have been at or below the rate of inflation.
the economy was far below potential.•
This was possible because
We should not expect, however, to see such
a relationship between inflation and interest rates go on indefinitely.
Monetary policy during 1972 should remain as an object lesson for a long period
of time.
During that year, monetary expansion was far too great.
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The cost of
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the relative inaction on the part of the Federal Reserve was the overheated
economy of 1973 and 1974 and the ensuing recession.
A touch of medicine in
1972 would have been preferable to the near financial panic of 1974.
Most of
the blame for that episode can be placed on the Federal Reserve, but Congress
should not put itself in the position of being the culprit the next time restraint
is needed.
If more comprehensive plans and numbers are demanded and received
by Congress, it must be willing to share responsibility for the tough decisions.
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Senator RIEGLE. May I just ask you one thing on that point, before
we go to the next panelist. That is that I think those of us who come
from areas like Michigan, which is very interest rate sensitive, and
I have always tended to view it as being on sort of the whip end of
the economy, I wonder 'whether the position there of being really
very sensitive, almost in an early warning kind of way tends to
influence either my observations or your own?
To what extent, as you try to identify that factor and think about
that versus really looking at this thing from a national standpoint,
do you feel that your position tends to make you even more apprehensive about the kinds of swings that we may be starting to make
right now?
Dr. THOMSON. I -suppose you have a good point, Senator, since
automobiles are obviously a very durable good, they can be postponed
in times of economic downturn. However, I do not believe my views
of monetary policy are heavily influenced by my particular environment. On the contrary, as a banker, I know high interest rates help
profits. I think, though, for the good of the country and consequently
the long run good of the banking industry and industry in general,
that it would be far better to draw out the current expansion longer.
I wish the Fed could see their way to being a little more moderate
in putting on the brakes this year. I think perhaps next year they
may have to be firmer.
Senator RIEGLE. Dr. Walters, we are delighted to have you-here. As
Senator Proxmire noted, you bring a very distinguished background
here, and we would be pleased to hear from you at this point.
STATEMENT OF JOAN G. WALTERS, PROFESSOR OF ECONOMICS,
FAIRFIELD UNIVERSITY, FAIRFIELD, CONN.
Dr. WALTERS. Mr. Chairman, I have a summary statement which
I will read, but I understand the full statement will be available to
the committee.
Senator RIEGLE. That is correct, and printed in the record.
Dr. WALTERS. My remarks focus upon the interaction between public expectations, inflation, and Governmental policy.
Consumers and businessmen, as well as participants in the financial
markets, are uncertain and hesitant about the economy, about inflation, and about future Government economic policy.
My suggestion is that Congress, the administration and the Federal
Reserve allay this uncertainty by clarifying Government's economic
goals for the coming 2 years. Control of inflation should be a prime
commitment. The statement of goals should be reinforced with cooperative action by Congress, the administration and the Federal
Reserve to implement and coordinate fiscal and monetary policy.
The public's expectations about inflation can be affected by Federal
fiscal policy and debt financing. Rising deficits are interpreted as
precursors of future inflation.
In the realm of monetary policy, expectations about inflation play
a significant role in determining the public's demand for money
and credit. At the same time, the public's expectations are affected
by monetary policy. Monetary target information can lead to expecta-
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98
tions of greater inflation and higher interest rates or can be interpreted in just the opposite manner if the public anticipates lessening
inflation.
Expectations come into play again when investors see that announced monetary targets are not being met. Then some guessing
about future Federal Reserve corrective action arises.
Questions can be raised about the nature of official Government
estimates of economic variables. What is their meaning and significance i Are they professional estimates or political expressions of
hope? How do these estimates affect the public's financial behavior?
After the administration makes clear its determination to control
inflation, fiscal and monetary policy must be used deftly. Both
Congress and the administration must decrease the size of the deficit.
This will be politically difficult, but nevertheless imperative for it
can have both a real and a psychological impact in moderating
inflation.
Monetary policy traditionally has been the main instrument to
achieve price stability, and it must continue to play a major role.
The aim should be to slow the growth rate of the money supply.
Fear of rising interest rates may be excessive. Flexible interest rates
have an important function in a free market economy.
Perhaps undue concern has arisen about the impact of interest
rates on the vitality of the housing market. Recently, expectations
of future inflation have lessened the dampening effect of interest rates
as more investors have turned to buying houses in preference to
financial assets. The interest rate component in decisions to invest in
housing has been swamped by expectations of future inflation in the
value of the asset.
Interpretation of the level of interest rates as high must make a
distinction between the nominal rate of interest and the real rate.
Both borrowers and lenders include an inflation premium in their
calculations of the effective interest rate, although we cannot be
precise about the amount.
Rather than emphasizing these aspects of interest rates, however,
more concern should be directed toward the possible adverse impact
of interest rates on business expenditures on plant and equipment.
Business sector spending has lagged during this recovery. In implementing slower growth rates for money, great care must be exercised
to insure that business has access to debt financing at reasonable
rates of interest. This objective necessitates a lower Federal Government deficit to a void crowding out in the later stages of the present
recovery.
A policy to encourage business capital expenditures, through tax
policy and monetary policy, will help in the struggle to control inflation by leading to increased productivity. In this context, fiscal
policy must back up monetary policy to simultaneously achieve
greater growth and less inflation.
Comment is in .order on two ideas which run counter to those
expressed in this paper. A Phillipsian type of analysis envisions no
beneficial role for monetary policy. It claims an increase in the money
supply leads to inflation; a decrease leads to unemployment. I find
this position unacceptable because it assumes a fixed relationship
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between the unemployment rate and the inflation rate. No such link
can be shown over different periods o:f time. September 1977 to March
1978 showed a moderate growth in the money supply, stabilized
inflation, and unemployment.
Some analysts point out that the present inflation is caused by
cost-push, and not by demand-pull. Therefore, they recommend
:faster growth in the money supply and believe it would lead, not to
increased inflation, but to 1.ncreased employment. Cost-push elements
are rightly singled out and should be the basis :for one set o:f policies.
However, increasing the rate o:f monetary growth cannot be viewed as
harmless. General cost increases usually are financed partly with an
increase in the money supply. It is doubtful all prices can rise unless
the money supply accommodates the increase. Furthermore, the
public's expectations about inflation could be adversely affected.
Apprehension about inflation could also spread to our international
trading partners. The complex nature o:f inflation and the lack of
precision in economic policy tools do not permit a tight policy for
costs and an easy policy :for demand.
In summary, I suggest a strong Government commitment to control inflation. Fiscal policy should be aimed at reducing the Federa]
deficit. Monetary policy should try to gradually decelerate the rate of
growth o:f the money supply, while allowing only very moderate
increases in interest rates. This is, admittedly, no easy task.
Thank you.
[The complete statement o:f Dr. Walters :follows:]
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EXPECTATIONS AND MONETARY POLICY
Joan G. Walters
Professor of Economics
Fairfield University
Fairfield, Connecticut
Mr. Chairman, members of the Committee, I thank you for
this opportunity to speak to you about monetary policy.
My remarks focus upon the interaction between public
expectations, inflation, and government policy.
Consumers and
businessmen, as well as participants in the financial markets,
are uncertain and hesitant about the economy and about future
government economic policy.
My suggestion is that Congress,
the Administration, and the Fed try to allay this uncertainty
by clarifying the government's economic goals for the
coming two years and by stressing their commitment to controlling inflation.
Monetary policy must serve as the main instru-
ment in moderating price increases, but fiscal policy must
accommodate monetary actions to prevent excessive increases in
interest rates.
I will first consider the role of expectations, and for
the purpose of these remarks I define "expectations" as the
public's anticipation of future economic matters and future
government economic policies.
Expectations involve a behavioral
variable which is difficult to measure.
There are many allu-
sions referring to the public's sentiment, mood, psychology,
confidence, uncertainty, and expectations in the economic literature, in the press, and in Congressional hearings.
Econo-
mists recognize that expectations play a significant role.
We
know expectations can affect the economic behavior of the market
participants and the response of the public to governmental
policy actions--to monetary and fiscal policy in particular.
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The public's expectations play a vital role in controlling inflation.
The amount and the type of spending by the public, that
is, by the consumer, are profoundly affected by uncertainty and
by expectations about inflation.
Psychological factors can and
do cause erratic, unanticipated fluctuations in saving as the
consumer swings from spending to saving and back to spending.
This behavior influences flows of funds into financial markets
and financial institutions.
Additionally, the expectations of
entrepreneurs change, causing fluctuations in investment and in
capital spending--Keynes noted that long ago.
Economists can only approximate psychological factors.
Surveys of public sentiment and of businesses' capital spending
plans have been more successful than quantitative models, but
leave much to be desired.
George Katona's work is important,
but his information is not often incorporated into models or
policy decisions.
To become more specific, I should like to consider expectations about fiscal policy and then about monetary policy.
First, the public's expectations can be affected by
Federal fiscal policy and debt financing.
seen as precursors of future inflation.
Rising deficits are
The response, there-
fore, to proposed tax cuts may be perverse, for the public may
anticipate larger deficits and so an increase in the inflation
rate.
Furthermore, unfulfilled campaign promises to balance
the budget leave people uneasy and uncertain about government
economic policies and, therefore, hesitant in their financial
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102
planning.
Larger federal deficits cause the financial markets
to anticipate higher interest rates, but the timing and amount
are uncertain.
Congressional budgetary behavior affects the
public's expectations about inflation.
Secondly, in the realm of monetary policy, expectations
play a significant role in determining the public's demand for
money and credit.
The rise in demand for money in 1977 has
been attributed in part to uncertainty about the job market,
future prices, and foreign exchange rates.
In addition, the
velocity of money is linked to expectations as well as to
financial market technology.
Part of the Federal Reserve's
difficulty in maintaining control over the supply of money
during short periods in 1977 has been attributed to shifting
public psychology.
The public's expectations are influenced by monetary policy.
There are two types of responses involved:
one, the
response to announcements of new target ranges for the monetary
aggregates; and two, the reaction to the Federal Reserve's
failure to achieve the target goals.
In FOMC policy releases and in testimony before this
Committee, the Federal Reserve provides information about future
monetary policy.
The public's interpretation of this data can-
not be fully ascertained.
If a new lower range for the aggre-
ga ,-,sis mentioned, the public expects tighter money and higher
interest rates to follow.
On the other hand, some people, per-
haps encouraged by the Fed's strong stand against inflation,
anticipate better economic conditions and lower futurr inflation
rates.
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Another psychological response could follow.
Aware that
the Federal Reserve is not attaining a previously stated goal,
sophisticated participants in the financial markets anticipate
future central bank corrective action, then act according to
their estimates of possible later Fed actions.
Perversely, the newly-required information on monetary
targets, rather than eliminating an unknown, has injected an
additional variable-··second guessing the Fed's future corrective actions.
The financial markets are now measuring weekly
money stock performance against the target goals, and considerable short-term instability has developed.
Federal Reserve
statements of target ranges, unfortunately, have been misinterpreted as hardline weekly goals.
Attention has been di-
verted from real factors to guessing policy.
The intention behind House Concurrent Resolution 133 and
Public Law 95-188 seems admirable, and a call for more information seems innocuous.
Projections with the imprimatur of the
Fed, however, have a special significance.
Turning to the subject of official government estimates,
let me raise some questions.
Various government spokesmen have
inundated us with estimates of GNP, of inflation rates, of unemployment rates, and of international deficits.
ments are not always in agreement.
these estimates?
official "hopes?"
The state-
What is the significance of
Are official forecasts realistic?
or are they
How much is professional projection and how
much political statement?
This situation probably has led to
confusion on the part of the public about the administration's
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104
overall economic plans.
The public has failed to discern a
commitment to controlling inflation and to managing our international finances.
Public confidence could be enhanced Kere
the administration to indicate its economic objectives and its
determination to bring greater price stability and to rebuild
our international financial stature.
More than one press con-
ference will be required.
Official statements expressing a commitment to stabilize
prices must be reinforced with two types of government policy
to achieve that goal, namely fiscal policy and monetary policy.
The present situation calls for moderation of Congressional and Administrative tudget policies.
hard political choices.
Congress faces some
Federal fiscal behavior can have both
a real and a psychological impact in controlling inflatiou.
A
restrained growth in Federal government budgets would help to
dampen inflation and should remove debt financing pressures from
the financial markets, thus moderating the need for interest
rates to move up.
Besides the real impact on the economy, a
sign of moderation in government spending could mollify the public's apprehension of an uncontrollable budget.
Monetary policy, traditionally, has been considered the
major instrument to control inflation.
In view of the current
state of economic knowledge, it must continue to assume the
primary role in our search for price stability.
A conservative
monetary policy which attempts to gradually decelerate the rate
of growth of the monetary aggregates should be followed.
This
policy would have beneficial real and psychological impacts.
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Monetary policy can achieve greater success if it is
backed up with moderate fiscal policy.
I wish to stress the
desirability of a cooperative effort by Congress, the Administration and the Federal Reserve, in attempting to control inflation and in implementing policy.
Slower monetary growth
rates without increases in the long-term interest rates can
only be achieved if Federal debt financing requirements decrease.
Some reluctance to rely on a flexible monetary policy
has been evident.
This hesitancy stems from a misunder-
standing about the role of interest rates, a fear of the impact of interest rates on housing, and a failure to recognize
the impact of inflationary expectations on interest rates.
Let me consider the role of interest rates.
All too
often, interest rates are viewed solely from the point of view
of the borrower, with the emphasis on the cost element.
are two sides to debt, however.
There
By fostering low interest
rates, are we not forcing the saver to subsidize the borrower?
A policy continuing to favor borrowers over lenders is misguided.
Federal tax laws allow the costs of borrowed money to
be deducted from gross income before taxes. Such policies indicate
emphasis on distributional equity to the detriment of efficiency
objectives.
Higher interest rates are not per se bad policy.
Interest rates perform valuable services if allowed to do
so.
They allocate credit in a free market.
Constant concern
with maintaining low borrowing costs for all sectors of the
economy at all times does not make sense.
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Rather, this attitude
106
arises from a basic mistrust of the functioning of the market
system and from a bias against maximizing efficient performance
of the economy.
Commentary on past monetary policy often indicates displeasure at rising interest rates.
The fear is expressed that
high interest rates will spill into the mortgage market and
have a negative impact on housing.
The implication is that
any tightening of monetary policy is to be avoided.
Let me comment on the relationship between mortgage
interest rates and housing.
In the past, an inverse link was
observed between mortgage rates and the quantity of housing
activity.
This traditional patter.n has not been so obvious in
the past five years.
Other considerations on the part of the
potential home·-buyer seem to have assumed greater importance
than the interest rate.
Expectations of the public about the future inflation
rate have affected housing demand.
It seems the general
public may be ahead of the economics profession in evaluating
the impact of inflation on real property as opposed to financial or paper assets.
Home-buyers have seen the value of
houses increase much more than the value of financial assets.
This is a typica)_ pattern under inflationary conditions, indicating the investors' distrust of dollar-denominated financial assets.
My point is that the public's expectations of
continuing inflation override or "swamp" the interest rate component in decisions to invest in housing.
Expectations about
inflation shift the demand curve for housing.
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Hence, in
107
assessing monetary policy, we overemphasize the detrimental
effects of interest rates in the housing market.
Mention should also be made of the effect of inflationary
expectations on the level of interest rates.
The borrower, ex-
pecting continued high inflation, reasons that debt will become
less burdensome as inflation continues.
The future dollars to
pay back debt have less purchasing power and are less valuable.
Furthermore, the borrower, as well as the lender, sees that all
prices have risen and views increases in the interest rates as
reasonable.
(Please remember:
this has occurred at a time when
greater information for the borrower has become mandatory and
has increased the borrower's knowledge of borrowing costs.)
Borrowers and lenders evidently make a distinction between "real" and "nominal" rates of interest.
The stated rate
of interest contains a payment for the use of money over a
period of time and also an inflation premium reflecting expectations about the future rate of inflation over the term of the
loan.
This is an idea first expressed by Irving Fisher.
My point here is that it is difficult to classify a
particular level of interest rates as being "high" unless we
know the amount of inflationary expectations built into the
nominal figure.
Simply stated, inflationary expectations drive
nominal interest rates higher.
I have commented here on some misconceptions about the
role of interest rates, on the effect of interest rates on
housing and on the effect of inflationary expectations on nominal interest rates.
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It is more important to be concerned about the possible
impact of interest rates on businesses' expenditures on plant
and equipment.
In implementing monetary policy, great care
must be taken to judge the impact of higher interest rates on
investment.
Spending by business in this recovery has lagged
behind rates in past recoveries.
Furthermore, the real profits
of business are unlikely to provide sufficient funds for
capital spending, necessitating reliance on outside financing.
With equity prices depressed, borrowing is likely to be crucial.
Therefore, government must design both corporate tax
policies and monetary policy to accommodate increased corporate
borrowing.
A policy of encouraging business capital expenditure is
vital in the struggle to control inflation because increased
capital per worker leads to increased productivity.
Recent low
inr.reases in productivity bode ill for future prices.
Delicate handling of money supply growth rates must
assure business of adequate financing.
Congress and the Admin-
istration must control the size of the deficit, hopefully lowering it.
Then business will not have to compete with the public
sector, and rising interest rates can be avoided.
During the
early phases of the current recovery, interest rates remained
steady.
As the economy moves into the later phases of the up-
swing, federal debt financing needs should be decreasing in
order to allow the private business sector to finance expansion
without interest rates moving up.
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Let me stress that the higher
109
interest rates result in part from Federal government fiscal
policies.
Let me comment on two ideas about the role of monetary
policy that I consider misleading.
Some doubts have been
raised about the importance of monetary policy.
Believers in a
simplified Philippsian relationship between jobs and inflation
tell us that an increase in inflation buys employment.
dilemma thus arises.
A
An.increase in the money supply growth
rate means more inflation; a decrease in monetary growth rates
means more unemployment.
This view presents a no-win situation,
indicating no possible beneficial role for monetary policy.
'l'he relationship implied between jobs and inflation can
be questioned.
No evidence of a consistent fixed relationship
between the unemployment rate and the inflation rate can be
shown.
mt..1t.
We now associate higher prices with higher unemployThe period from September 1977 to February 1978 showed
moderate growth in the money supply, stabilized inflation and
a falling unemployment rate.
This performance would seem to
discredit the idea that monetary policy can only be used for
one objective at a time.
Another line of analysis says that the present inflation
is caused by "cost-push" factors, not by "demand-pull."
It
goes on to suggest faster growth in the monetary aggregates as
a way to spur employment.
Since demand is moderate and unused
capacity exists,no acceleration of inflation is likely to follow the increased rate of growth in the money supply.
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"Cost-push"elements are rightly singled out and should be
the basis for one set of policies.
I would disagree strongly,
however, with the statement that nothing is to be feared from
an expansionary monetary policy at the present time.
First,
general cost increases must be financed with increases in the
money supply.
It is doubtful all prices can rise unless the
money supply accommodates the increases.
Secondly, the argu-
ment overlooks the effect of monetary policy on expectations.
Should consumers notice
faster growth in the money supply,
their fears of future increases in the inflation rate would
increase.
In addition, an expansionary monetary policy would
not be viewed favorably in the international markets.
The
complex nature of inflation does not permit a tight policy for
costs and an easy policy for demand.
My position is that monetary policy· can be used effectively to control prices.
A flexible monetary policy will re-
quire slower growth rates for the money supply.
If decreased Federal government deficits can be achieved,
upward pressure on interest rates could be eliminated, and
business expenditures on plant and equipment would be encouraged.
This would extend the recovery and slow inflation via
productivity increases.
In summary, my comments today have centered on the interaction of the public's expectations, inflation, and government
policies.
One suggestion is that the Congress, the Administra-
tion, and the Federal Reserve address the problem of confidence
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by clarifying government economic policy objectives for the
next two years.
Make the general public aware of a coordinated
official set of economic priorities.
Identify the moderation
of inflation as a prime commitment.
Actual policy implementation must come on two fronts:
fiscal policy and monetary policy.
Congressional and Adminis-
trative awareness of the importance of their respective spending policies on the rate of inflation are mandatory.
Political
chokes must be made by Congress and the President, and some
seemingly desirable programs must be cut or postponed.
The
rate of growth of Federal spending must be related to GNP
growth.
Monetary policy remains the main technique for moderating
price increases.
are necessary.
Gradually decelerating monetary growth rates
The policy must be implemented with care in
order to avoid sharp increases in interest rates that could shut
business out of the credit markets and slow investmen~ spending.
Presumably this difficult task for monetary policy can only be
achieved with the cooperation of Congress and the Administration
in decreasing the Federal deficit.
It is important to restore
the public's belief in government's willingness and ability to
deal with its own finances and, hence, with inflation.
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Senator RIEGLE. Well, let me thank all of you again for your testimony.
Let me ask you to react, if I may, to an item in a Federal Reserve
press release dated April 21. It was just released last week. It makes
refer.ence to certain policy actions that the Federal open Market
Committee took at its meeting of March 21 of this year.
One of the interesting quotes is this:
"The Committee members agreed that the rate of price advance was likely
to remain relatively rapid in 1978 and they expressed a great deal of concern
about this prospect. The comment was made the pace in increases in price
appear to be accelerating in this country, while decelerating in European
countries.
And this is the part· I want to call your attention to.
Several members observed that inflation led to recession, and it was suggested
the greater the inflation, the worse the ensuing recession. For that reason it
was suggested special emphasis should be given to the Committee's longstanding objective of helping to resist inflationary pressures while simultaneously
encouraging continued economic expansion.
I wonder in terms of what causes what, a very complex multifaceted economic picture, whether you would agree with this notion,
that inflation leads to recession, and the greater the inflation, the
worse the ensuing recession. Dr. Rested
Dr. HESTER. I believe that it is not a demonstrated fact that inflation leads to recession, other than in the simple sense that something
that goes up often eventually comes down. But that is not an operative
or useful bit of information. One needs to know when it comes down
and under what circumstances it comes down. The Federal Reserve
may itself be responsible for bringing it down after an inflationary
period by raising interest rates excessively. It is irresponsible to
suggest that just because there is some inflation a recession will
follow.
This country had high rates of inflation in 1950 and 1951, shortly
after the start of the Korean war, and we managed to get out of
that without a sharp recession. We had high rates of inflation between 1946 and 1948 and didn't go into a severe recession. There was
a period of fairly high inflation from 1956 until 1960 and we did
manage to produce recessions, but that was because the Federal
Reserve drove interest rates up to high levels both in 1957 and in
1959 and 1960.
Senator RIEGLE. Dr. Thomson.
Dr. THOMSON. I think in that record they are setting up a case for
a more stringent monetary policy. I think one, though, has to realize
that you can't take an edge off inflation without taking an edge off
the whole economy.
Inflation is a result of ill-conceived policies or mistakes, perhaps,
of the past. The inflation we are having in 1978 thus far has little
to do with anything that is being done on the policy front in 1978.
If one tightens policy now one will also reduce future real growth
as well as inflation. So the cost of an aggressive inflation policy now
is quite high in the face of an economy which still has a lot of slack.
The economy by almost any standards can't be conceived as being
one in which we are bursting at the seams. The unemployment rate
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is still 6.1 percent. Capacity utilization rates according to the Federal
Reserve are still 83 percent. One doesn't look around the economy
and see anything like the conditions we had in 1973, in which everybody was buying in anticipation of price rises, and there were many
isolated shortages in paper, steel, and other sectors of the economy.
We don't have those conditions now. So what tight money will
probably do now is take some slight edge off the future inflation, but
it will also take a greater edge off our real growth. It seems to be a
poor tradeoff now. At some future time, maybe 1979 or 1980, the
economy will be up to :full capacity and tighter policy will be
called :for. Right now I don't think so.
Senator RIEGLE. I might just comment in passing that the thing
that disturbs me, unless we are talking about a major recession, major
downturn, if it is something less than that, but still a downturn,
there is a question in my mind of the degree to which that finally
translates itself into an antiinflation effect.
In other words, as I look at the pattern of price and wage increases
over a period of time, and the generalized inflationary pressure we
are getting, it seems to me certain key components are not all that
much affected in a very basic way by whether or not the economy is
in a sliding phase. There is some of that, hut some of the places
where the biggest components of price increases are coming in are
so strongly entrenched and so squared away, it seems to me we are
likely to get about as much with or without an upturn or downturn
in the economy, which is another issue or problem, but it may also
say the notion of a recession to cure inflation is becoming more a
myth than fact.
·Dr. THOMSON. I think you make some relevant observations. We
do have the disease of inflation, it is a disease we are not going to
get rid of for quite a while. It doesn't mean we should not strive to
get rid of it, but the process of getting rid of it is a 4- or 5-year
project.
It is not-a project you launch at a time when the economy is not
looking all that healthy.
Senator RIEGLE. Yes. Dr. Walters~
Dr. WALTERS. Boiling it down to "inflation causes a recession" is a
little over-simplified. Nothing in economics is that easy, as any economics professor can tell you. I can't accept this neat process that
says when the inflation rates get high, it must necessarily be followed
by a recession. It certainly happened in the 1970's. The factors
operated together in the downturn in 1974-75, but certainly a combination of other things occurred. I think inflation causing a recession
is sometimes referred to as the "new" theory, but there is always a
newer theory that comes later. I would say in terms of monetary
policy, I don't think fighting inflation can be done in terms of any
single instrument. I think you have to combine monetary policy and
fiscal policy. When I say move to slower rates of growth in the
money supply, I do not mean to jump into tight money. But one way
you can avoid this over-reaction which monetary policy usually falls
into is with cooperative Congressional action in terms of the budget.
Because if we have high interest rates, they don't come from monetary policy alone. There is a great big money market, a debt market,
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Federal Reserve Bank of St. Louis
and one of the big competitors in the debt market is the U.S. Government. As long as the U.S. Government is financing a deficit of
$60 billion or more, it creates huge demands for this pool of funds
and has an impact on the interest rate just as much as does the
Federal Reserve trading in the bond market.
So when I say evening out monetary policy, the Fed can't do it
alone. I think it is only one policy tool, particularly, in this socalled predominantly cost-push inflation. But I think it is important
in the cost-push aspect of inflation, to increase productivity. I don't
think enough has been said this morning about the lags in business
spending and the consequent fall in productivity. I think that is
why again interest rates must rise very severely because the weakest
element at this point is not the consumer, but the business sector. And
plant and equipment expenditures have been much slower than in
other upswings, and changes in plant and equipment affect productivity. That is the basic attack on cost-push inflation.
Senator RIEGLE. I appreciate the point on productivity. The statistics that we have were levelled out in terms of productivity again
over the last several years and are not particularly encouraging,
when one matches that with what we see in terms of increases in
wagrs and goods.
One area that concerns me and where I am seeing that happening
right now is in the communications business. AT&T is in the proce,,;s
of automating at a rapid rate at a number of facilities in Michigan,
and I assume elsewhere, so we are finding an awful lot of people who
have been employed as switchboard operators and so forth are now
being replaced by electronic circuitry, so we are getting pockets of
displaced workers.
Now in a sense we may or may not be getting a productivity gain
in terms of what we finally get in the way 0£ the volume of AT&T
service per dollar spent, but it seems to me we will be picking up a
different kind of problem over here in terms of people who are pushed
out of the labor market and it might be very hard, I think will in
fact be very hard to absorb.
I want to come back and raise another item with you. That is, it
seems to me implicit in what all of you are saying to a greater or
lesser degree is-this is my own sort of summary of it, so if you care
to dissent, please do-but it seems to me that you are expressing a
concern that maybe the Fed is reacting in perhaps almost an irresponsible fashion for a variety of reasons. It is not surprising that
they might be doing that, and perhaps over-reacting to a problem
where a reach for the conventional remedy, namely, tighter money
in terms of trying to deal with what is obviously foreseen as a serious
inflation problem is exactly the wrong reflex to use at this time.
I can see why that might happen, because we have a new person
at the Fed, who I think wants to get off to a strong start and wants
to show action, and I also think that we have got something of a
leadership vacuum that exists in terms of national policy setting
of economic strategy.
This is no secret, everybody is writing about it. It is perceived by
international observers as well as domestic observers that pay atten-
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tion to it, and both in terms of some of the difficulties that the Carter
Administration has had in its overall efforts, as well as some of the
changes in the Congress in terms of our ability to provide alternative
Congressional leadership if that is what is required, I think has
created a situation where there may be something of a real gap in
terms of taking the lead in economic policy strategy and formulation.
It is easy for me to see why that is generally the case, that the
Federal Reserve, particularly with somebody new at the helm, who
is a charger out of business, would be inclined to want to say, you
know, let's do something that is visible. In other words, let's take a
step everybody can see and react to, so they know at least this shop
means business and unless we get the restraint other places, wages,
prices, government spending, various other things, we are going to
wrap the system around ourselves.
If that is generally the case, then I am alarmed, and I may well
be more alarmed than you are, although I detect a sense of alarm from
each of your statements, to the effect you would be very reluctant
to see monetary policy used at this point as the central tool for trying
to deal with an inflationary problem that could basically throw the
country off track and into an economic tailspin that no one wants.
That, essentially, is the summary I get here. I would appreciate
any comments that anybody wants to make along that line.
··.
Dr. HESTER. I would like to react briefly. First of all, I think your
general characterization of what the Federal Reserve is trying to do
is correct.
I would like to comment briefly-Dr. Eckstein is not here nowon what he said this morning about the possibility of a rapid growth
in consumer spending. As I read the statistics, consumer saving is
still quite low, and I don't see a large increase in consumer spending
in the coming quarter. I do see the possibility of rapidly rising
interest rates inflicting a certain amount of damage on household
solvency.
I am not talking about prices, I am talking about pressure, which
may curb further spending increases. Consumer demand will not be
as high as he estimated. Rising interest rates will defer spending
further. It is important at this stage not to rock the boat in that
direction.
The second thing which should be said is that it is extremely
dangerous to attempt to deflate the economy very rapidly. By deflate, I mean reduce the inflation rate from perhaps 7 percent, which
we are likely to have this year, or 8 percent next year, by 2 or 3 perment. If you try to do that rapidly, you will cause people's expectations to be adversely affected, and it is quite possible people will find
themselves in some difficulty.
We have had occasions when sharp changes in credit conditions
have produced crises. The Penn 'Central incident is an example.
Dr. THOMSON. I would like to echo what Don said, except I want
to make clear that 3 months from now it may look as though the consumer has been on a rampage. I think we have to be careful in interpreting the current data. The consumer decreased spending in January
and February. We naturally are getting a bounce right now and the
data are indicating this.
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The second quarter will probably have high growth rates. I personally wouldn't estimate the second quarter GNP growth rate as
high as Professor Eckstein, but I think it can be 6 percent real growth,
maybe even 7 percent. But that is an accident of the way the year
unfolded. I think that inflation can only be brought down, as I mentioned before, very gradually. If we attempted to cure the disease
withiJ?- a year's period, it would do so by setting off a very severe
recess10n.
Dr. WALTERS. I am not sure I am as worried about the consumer
as I am about business. I think the consumer traditionally has been
rather insensitive to interest rates. Consumer interest rates do not
change that much, consumer finance rates.
I also think the consumer has plunged into housing, in spite of
rising interest rates, because they think the interest rate is not as
important in terms of the inflation as the price of the house or the
price of the asset they are buying.
In other words, usually the expectations about future inflation
affect the consumer's behavior more than the interest rate. Even before
the higher rates of inflation, the consumer was traditionally insensitive to interest rates, even with the new truth-in-lending information with all sorts of statements about understanding the interest
rates charged over the long term.
That is why I said I think business is much more sensitive to
changes in interest rates, and therefore that is the area where we
have to be concerned about instant monetary policy, which I certainly would be afraid of. I say that nothing should be done quickly,
and business investment decisions come over long periods of time,
and they can be postponed.
It is my understanding that business liquidity is not extremely high
at this point, so they must rely on the debt market, not on the equity
market, and therefore they will be very sensitive to changes in the
interest rate.
Senator RIEGLE. You know in the professional financial and economic circles in which you all work and travel, is it a fair characterization to say that most of you and your colleagues are feeling
that there is something of a leadership vacuum at the moment in
terms of Federal economic strategy?
Is that a fair characterization, not laying the blame on any one
door step, but the entire picture?
Dr. HESTER. I think the general conception is there has been a
leadership vacuum since perhaps 1967, when the Vietnam-The CHAIRMAN. Since when did you say?
Dr. HESTER. 1967. I think there is a great deal of concern about
that. I think that has happened for various reason, which we shouldn't
go into now.
Senator RIEGLE. Is it the perception in today's situation, where we
are today, that it is somewhat different and more distressing than
what we may have seen in 1967 or 1972, or some point along the way!
In other words, are you saying it is basically more the same or
are you saying there is a perception now that maybe because conditions have changed, and other factors are loose, maybe our margin for
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error is diminished, but now there is even a heightened concern about
a perceived leadership vacuum?
.
Dr. HESTER. I think there has been a cumulative effect 0£ the
oscillations in 1972, 1973 and 1974. Events 0£ those years have tended
to raise people's awareness and concern, people are becoming more
uneasy. As nearly as I can reconstruct, what must have happened
here is shown thus.
I would also like to react briefly to an earlier statement by Dr.
'\Valters. I agree consumers are not ordinarily too sensitive to interest
rates. But the important area where inflation is occurring is in housing. H you really crack down on housing badly, house prices would
£all rapidly and then some fairly severe losses could be created £or
the consumers. It is not like buying oranges and apples.
Senator RIEGLE. H interest rates go up and housing starts to go
down, it is hard to break the price 0£ housing.
Dr. 1VALTERS. Has the price 0£ housing gone down in the last 30
years, except in places where large industry has moved out? I am
not aware 0£ any housing in the country that has fallen in price.
Senator RIEGLE. I am hard-pressed to remember a time in the last
15 years where it has risen as rapidly as in the last couple 0£ years.
Dr. WALTERS. I think the consumer has noted that and gone into
housing more heavily.
Senator RIEGLE. Senator Proxmire.
The CHAIRMAN. [presiding]. I will follow right up on that, Dr.
vValters. I would agree with you that business can be very sensitive
to interest rate changes. But I think there is no question that all the
studies indicate that the credit crunch really comes down awfully
hard on housing. Chairman Maisel's study in 1967 showed housing
suffered on the basis 0£ his analysis-and I haven't seen it questioned
by anybody-70 percent 0£ the credit crunch was visited on housing, constituting 3½ percent 0£ the GNP. The reason is simple, 0£
course. '\Vhen interest rates go up, the monthly payments increase
and you just knock out hundreds 0£ thousands 0£ families out 0£ the
housing market, and as a result you go into the kind 0£ devastating
slump we went into.
That is the consumer who is unable to pay.
Dr. WALTERS. I think the credit crunch came because 0£ disintermediation, which meant no funds were available. I don't think we are
near that point right now. I think the mutual savings and savings and
loans are pretty well stocked.
The CHAIRMAN. Look at chart 3.
Dr. WALTERS. I am aware 0£ that. It is still a net inflow. Money is
still available for housing. I think the availability 0£ it is more
important than the interest rate.
Technically, there shoudn't be two things, except with a regulated
ceiling, we do have two questions, the price and the availability.
Money is very available.
The CHAIRMAN. You can have plenty 0£ money available at 10 or
15 percent mortgage rates, and you have lots 0£ people who would
be able to buy at 9, a lot 0£ people at 8, and a tremendous number at
7. As you go up, you can say it is available all right, but it will just
knock people out of the market.
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Dr. WALTERS. I guess I don't :feel that housing is sacrosanct, that
part of the role of interest rates is to allocate a pool of credit, and
that at all times housing should not be maintained at a steady rate
and always favored over some other part of development, some other
borrower.
The CHAIRMAN. We certainly are a long way from that. My God,
think what happened in 1973. In 1968 it was my amendment that was
adopted by the Congress that provided for a goal of 26 million
housing starts over the ensuing 10 years. That was arrived at after
a considerable amount of thought and it may have been a little too
high, but that was the goal, 2.6 million starts a year. The 1975 housing
starts were 1 million-1 million. Absolutely appalling.
Now that kind of effect in housing which of course is not only
important in itself, but affects so many other purchases of :furnishings, automobiles, many other things that go with people buying a
home.
It seems to me it was a central element in the recession we suffered.
Dr. WALTERS. The recession of 1969 i
The CHAIRMAN. I am talking about 1975. There are a lot of other
elements that came into that in 1975, including energy, of course.
But I think the housing recession was important.
Dr. Thomson, your scheme for the Federal Reserve reporting to
Congress is very close to one I would like to see in place. The Federal
Reserve argued, however, if it gave out forecasts, the policies could
be misconstrued.
Do you see any harm in the Fed giving out economic forecasts i
Dr. THOMSON. Absolutely not. I think that the fear of giving out
the forecasts is greatly overdone. They fear if they put out a forecast and include interest rates, the market woud immediately adopt
their expectations and interest rates would move as soon as announced.
I think the public would soon learn the Federal Reserve's forecasts
are no better than the rest of our forecasts. I know they do a good
job and I have a high respect for the staff of the Fed. I don't however, believe that monetary policy should come out of a black box
any more than fiscal policy should come out of a black box.
Fiscal policy is considered effective, even though we all read in
the paper each day how fiscal policy is evolving, as proposals are
made by the Executive and the Congress makes modifications. I can
see nothing wrong with the Fed releasing its staff projections o:f
expected GNP and its staff projections of monetary growth.
I think that in a democracy it is absolutely essential.
The CHAIRMAN. Dr. Rested
Dr. HESTER. I see nothing wrong with releasing staff projections
either. While Federal Reserve staff forecasts are very good, like
every other forecaster, they make large errors. No sensible person
would take the forecasts seriously as being accurate or "right."
Furthermore, people are not so foolish as to respond only to such a
forecast. The Federal Reserve is looking at a large number of variables all of the time, responding to things above and beyond the
GNP forecast or some estimate of price inflation. They are responding
to many different sectors. Nevertheless, publication of their forecast
would facilitate coordination of government policy.
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Dr. WALTERS. I would agree with my colleagues. I see some problems but I have no objection to their publishing :forecasts. I hope the
public is aware of the problems of all :forecasts.
The CHAIRMAN. Dr. Walters, I would like to-incidentally I neglected to commend you on the fact that you were Outstanding
Educator of America in 1974-75. And I understand why, because one
o:f your pupils, I understand, was Jerry Buckley. Anybody who can
educate Jerry Buckley deserves an award.
Dr. WALTERS. Thank you.
The CHAIRMAN. He is a tremendously valuable member of our staff.
Dr. WALTERS. I am delighted he is a credit to Fairfield University.
The CHAIRMAN. Mr. Hester, could you explain in more detail the
advantages to a bank to receive deposits through its offshore branches
rather than its domestic offices?
Also could you explain the problems this creates :for monetary
policy?
Dr. HESTER. If a firm manages to have a compensating balance on
deposit in London, say, its bank would not have to hold reserve requirements against those :funds. Therefore the value o:f those deposits
as compensation to the bank would be worth about 20 percent more
to the bank in profit terms, because those funds, all o:f them, can be
invested :for example in Eurodollar securities. If the balances are
kept in a domestic branch only a fraction, one minus the reserve
requirement, can be invested.
The CHAIRMAN. Is there any tax advantage for the bank in that 1
Dr. HESTER. The tax advantages to the bank do not occur in the
foreign branches, because foreign branches must pay taxes on their
earnings immediately upon receipt. However, the banks will be able
to realize tax advantages if they operate in such a way as to locate
their earnings in foreign subsidiaries. The income tax regulations
do not require subsidiaries to consolidate their income for tax purposes. A firm doesn't have to pay taxes on subsidiaries' earnings until
they are repatriated.
The CHAIRMAN. In light of the :fact that there has been a great
change, with a colossal affluence in the Middle East and elsewhere,
can you explain the problem this creates for monetary policy?
Dr. HESTER. It creates problems. In my statement I indicate that
the recent international monetary situation cannot be examined independently of political postures.
Banks frequently are rewarded for providing services, loans and
other information processes by receiving compensating balances.
Funds offshore can provide such balances and also finance loans to
be made to domestic firms. Once balances are located in offshore
branches, multinational firms may easily be able to borrow from those
offshore branches, and disclosure may not be quite as complete in
terms of business loans outstanding. The Federal Reserve would not
necessarily recognize a loan which is made abroad as the equivalent
of a loan made domestically. If the Federal Reserve is using measures
on loan volume to generate information about the state of the economy,
it might be misled.
In general information flows to the Federal Reserve about "domestic" monetary aggregates are deteriorating as a result of operations
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abroad. I should add, as I stated in the paper, that we do not really
know the extent to which this is occurring. We know there are statements made by various Chairmen o:f the Federal Reserve to discourage that. But we don't know the volume o:f offshore business that
is truly o:f a domestic character.
The CHAIRMAN. In recent weeks, Dr. Hester, the growth o:f demand
deposits has been very slow. You said in your statement that repurchase agreements, that is, overnight purchase o:f :funds by banks
:from nonbank customers, has been increasing.
Dr. HESTER. Yes, very rapidly. The latest data we have suggest
that they are considerably more than 10 percent o:f M 1 •
The CHAIRMAN. This could affect the amount o:f demand deposits
in the system. I missed your oral presentation, so I would appreciate
your explaining this again.
I would also like to know how important you think this :factor is
in terms o:f the growth o:f M 1 • Is it really a big enough :factor for us
to be concerned about it?
Dr. HESTER. I did mention while you were absent that an estimate
o:f the volume o:f repurchase agreements outstanding is $45.8 billion,
or about 15 percent o:f M 1 •
This estimate was obtained by summing :funds which have been
purchased by banks in the Federal :funds market and through repurchase agreements and subtracting all :funds which the commercial
banks have sold. So the number is net acquisitions o:f :funds from
other than banks.
The CHAIRMAN. Should that be included in M1 ?
Dr. HESTER. I would be inclined to-i:f one wishes to stick to M 1 • I
think it should be included in M1 , yes, because it is overnight money,
and it can be used all day long. It is constantly being used as demand
deposits.
The CHAIRMAN. Wouldn't that make a one-time increase o:f about
15 percent?
Dr. HESTER. It would be a 15-percent increase. But it has already
occurred, o:f course.
The volume o:f repurchased :funds could grow considerably larger.
I:f one interprets repurchased :funds as money, as I recommend, member banks theoretically could monetize almost all o:f their holdings o:f
U.S. Government and agency securities. Their holdings were about
$93 billion at the end o:f September 1977. In my statement I point
out that agency issues are growing rapidly; together with continuing
Federal deficits the volume o:f potential repurchase is likely to expand
considerably in coming years.
The CHAIRMAN. We have to simply acknowledge it?
Dr. HESTER. Yes, we have to acknowledge it. It has already happened.
The CHAIRMAN. Dr. Walters, you said in your statement that monetary policy should attempt to gradually decelerate the rate o:f growth
o:f the monetary aggregates.
Should that be interpreted as a steady decline in the growth rates
over time, or a more flexible approach o:f bringing them down taking
into account economic conditions?
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Dr. WALTERS. Taking into account economic conditions. But I
think we should have longer term goals. I think in concentrating on
quarterly estimates, quarterly targets, we can get figures that have
gotten us out of line.
I welcome Mr. Santow's suggestion this morning of setting a target
on a yearly basis, 'and making judgments in terms of the whole year,
instead of every quarter changing targets.
The CHAIRMAN. So if, when Chairman Miller comes oofore us
tomorrow, his targets were not changed, you couldn't consider that
as a signal that they are not following the policy of gradually changing or reducing them?
Dr. WALTERS. No; I think they are hesitant to make a decisive move
to change the direction of monetary growth rates. On the other hand,
I don't think we should recommend higher targets, because I think
you are getting expectations about more inflation, expectations about
the future which upsets the financial markets.
The CHAIRMAN. I want to thank you all very much; this has been
an excellent panel, a fine morning. I apologize for missing some of
:ymir responses. You have made an excellent record for us, which is
going to be very useful in questioning Chairman Miller tomorrow.
The committee will stand in recess until 10 o'clock tomorrow
morning.
[Thereupon, at 12 :35 p.m. the hearing was recessed to reconvene at
10 a.m. the following day.]
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SECOND MEETING ON THE CONDUCT OF MONETARY
POLICY
TUESDAY, APRIL 25, 1978
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washing ton, D .0.
The committee met at 10 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire, chairman of the committee,
presiding.
Present: Senators Proxmire, Morgan, Sarbanes, Tower, Lugar, and
Schmitt.
STATEMENT OF CHAIRMAN PROXMIRE
The CHAIRMAN. The committee will come to order.
I apologize, Mr. Chairman, for keeping you waiting. We expected
another Senator who's on his way, and he wanted us to hold it up,
but I think he will be here shortly.
This morning we continue our oversight hearings on the conduct
of monetary policy by the Federal Reserve System. We have with us
today the Chairman of the Federal Reserve Board, Mr. G. William
Miller, who will explain to the committee the Federal Reserve's
monetary policy strategy for the coming year.
Chairman Miller, it has become very clear during the last several
weeks that you intend to let everyone know from the outset that even
though you are the new boy in town, and at the Federal Reserve,
you are going to take a hard line on inflation and replace Dr. Burns
as the Nation's No. 1 inflation fighter. Like Dr. Burns, you have been
right up in the forefront giving advice to the President and the
Congress on how they should manage fiscal policy matters.
Under your leadership the Federal Open Market Committee has
recently decided, it appears, to tighten credit by moving the Federal
funds rate target up to at least 7 percent, and perhaps higher. Some
accounts of this change in policy, not my own, have attributed it to
a determination by the Federal Reserve to give strong signals to the
financial markets and business that inflation is the No. 1 economic
problem confronting this Nation, and you will restrain credit growth
to keep inflation from rising. However, all the analyses of our
current inflation that I have seen indicates the basic inflation problems as being structural in nature and related to supply rather than
demand. Thus, it is difficult to see what real advantage tighter monetary policy will provide against inflation, unless, of course, the
Federal Reserve's policies get so restrictive that another recession
is induced.
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I hope that in your testimony and afterward you will take this
opportunity to explain the Federal Reserve's policy objectives for the
next year in very clear and precise terms that will allow this committee and the Nation to know exactly what efl:'ects monetary policy
is intended to have on inflation, on unemployment, and on production.
On all counts your recent tightening seems to be inappropriate. The
economy has slowed down over the last year on a pretty steady basis
with the growth of real GNP getting progressively lower in each of
the last £our quarters and turning negative during the first quarter of
this year. The monetary aggregates on a quarterly basis have followed
a similar pattern as can be seen quite clearly by the charts we have
set up over on the left. Currently, those monetary aggregates are well
within the ranges specified by the Open Market Committee as they
were announced to this committee last November.
Yesterday we received testimony from several witnesses, including
Dr. Otto Eckstein of Data Resources Inc., and Dr. Thomas Thomson
of Detroit Bank & Trust Co., as well as three other distinguished
witnesses. Both Dr. Eckstein and Dr. Thomson indicated their expectations £or weaker economic conditions in the second half of the
year and beyond. These forecasts are consistent with the President's
Economic Report and with part of the policy record released last
Friday of the Open Market Committee's March 21, 1978, meeting. On
page 17, the Open Market Committee record says:
It was also suggested that a firming of money market conditions in the
absence of actual evidence of excessive growth of the monetary aggregates
would be premature, given the weakness of recent economic statistics, the still
unsettled coal strike, and uncertainty about the strength of the prospective
rebound in economic activity.
All indications are that we are experiencing a "snapback" in
economic activity that had been dampened by the winter and the
coal strike. This rapid pickup is abnormal, and few economists expect
it to continue beyond the second quarter. Given the lags between
policy-induced changes in interest rates and changes in the monetary aggregates, especially M 1 , the Federal Reserve's current policy
of fostering a Federal funds rate of 7 percent or more carries with
it the very real possibility of creating very serious difficulties £or the
economy later this year-slowing economic growth, creating serious
financial conditions £or the housing markets, while doing very little,
or nothing, to reduce inflation.
It is increasingly evident to me that the Federal Reserve must do
a better job in explaining its policies. The growth ranges for the
monetary aggregates are just not enough. In deciding upon monetary
policy, the Federal Reserve considers current economic conditions
as well as forecasts £or the future before it decides on its monetary
aggregate target ranges. And if we are to understand those ranges,
we must also-know what specific relationship the monetary aggregates
targets have to the economy in rather precise terms, and over a fixed
time period, rather than periods that change and continually shift
forward from one base period to another each quarter. All of our
witnesses yesterday agreed that these changes in reporting need to
be made, that the Federal Reserve's numerical economic forecasts
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ought to be provided, and that the Federal Reserve's ability to conduct monetary policy would not be impafred if that were done. These
witnesses were the most distinguished group of economists the committee has ever had before it in the conduct of monetary policy.
Mr. Miller, you have not been at the Federal Reserve very long at
this point. Most of the changes in the economy and in the monetary
aggregates that we see developing now were determined by decisions
made before you became Chairman. We cannot hold you responsible
for these results. But that is not true of the recent increase in the
Federal funds rate to 7 percent and any additional increases that
may be forthcoming. Every witness we heard from yesterday expressed surprise at the timing of this interest rate rise, and the
consensus was that it is unwarranted. They may be wrong and you
may be correct; time will tell. If they happen to be correct, the
prospects for the economy are not at all satisfactorv from my view~~I am looking forward to hearing your statement and to getting
your explanations of recent events.
Senator Tower.
-
STATEMENT OF SENATOR TOWER
Senator TowER. Thank you, Mr. Chairman.
Chairman Miller, I'd like to welcome you in your first appearance
before the committee and note that you have taken the Job under
rather difficult and trying circumstances and that you will undoubtedly hear a lot of troubling questions and well-intentioned advice today. This is nothing new, as any of your predecessors could
tell you, but you are in a somewhat enviable position today. You
don't have to take responsibility for actions taken by the Federal
Reserve in the past and you have a rare opportunity to influence its
actions in the future.
Like other members of the committee, I have great respect for the
independence of the Fed. Nevertheless, I can't pass up this opportunity to encourage you and other members of the Board, as well
as the Federal Open Market Committee, to pursue a noninflationary
monetary policy. I recognize that the Fed can't fight the battle alone.
It will take the combined and determined efforts of the administration, the Congress, and the public in general if inflation is ever to be
brought under control.
I also recognize that you will be receiving a lot of conflicting advice
on the matter. There are those who will encourage you to pursue a
more expansionary course for monetary policy over the months
ahead and an expansionary monetary policy has a great deal of
appeal to it under existing conditions. Unemployment is still unacceptably high. Interest rates are higher than desirable and saving
inflows at mortgage lending institutions appear to have moderated.
Nevertheless, we should not lose sight of the damaging effect which
inflation brought on by rapid monetary growth has on the long run
health of our economy. It makes employment unstable, financial
markets uncertain, and real economic growth unachievable. The
record is rather clear on this matter.
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The rate o:f growth in money has been on an upward trend, particularly since the mid-1960's. Yet there's been no discernible upward
trend in real output over that same period and the rate o:f inflation
is higher and so are interest rates.
In my view these events should sound a note o:f caution in continuing to rely on monetary policies that push the economy beyond its
long-run ability to increase real output. I might add that I think
that the restoration o:f the confidence o:f the business community in
Government is enormously important these days and I hope, Mr.
Chairman, that you share my concerns on this matter.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Lugar.
Senator LuGAR. No statement.
The CHAIRMAN. Senator Schmitt.
STATEMENT OF SENATOR SCHMITT
Senator SCHMITT. Thank you, Mr. Chairman. And I also welcome
you, Mr. Miller.
Mr. Chairman, I continue to be encouraged by what I hear out
o:f the Federal Reserve Board this year, although the overall economic indicators are equally disturbing in many respects. I'm looking
:forward to Mr. Miller's first evaluation o:f the actual performance o:f
the economy. On the other hand, the administration's activities get
more and more disturbing as there is a continuing impression that it,
the administration, blames the country rather than the Government
:for our economic problems. The President's influence on monetary
policy is through fiscal and other policy recommendations to Congress
and through moral persuasion. Frankly, in the eyes o:f this Senator,
both the policy recommendations and the moral persuasion are inadequate.
Tax cuts without spending cuts and the recently imposed coal
settlement are the most recent examples one can point to.
The most critical economic problems :facing us domestically and
internationally are inflation, productivity, unemployment, and the
export-import imbalance. Although the symptoms o:f these problems
rein:force each other, there are commonsense solutions to each problem. I:f we begin to solve the problems the symptoms will begin to
recede.
Let me suggest the :following commonsense approaches to these
:four problems. These approaches should be thought o:f as an interrelated package. I will ask our witnesses to comment on each of
them during my question period and in detail :for the record and,
Mr. Chairman, I might mention to some considerable degree yesterday in our first panel we had some excellent commentary on these
types o:f approaches.
First, with respect to inflation, our 5-year fiscal policy should (1)
Reduce the net Federal deficit by $10 billion a year; (2) permanently
reduce taxes on the productive portions o:f our economy by $10 billion
a year; and (3) reduce the rate o:f growth o:f the Federal budget by
2 percent per year. The Federal :funds rate should be held below 7
percent so that the credit market can stabilize and related pressures
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toward the recession can be reduced or eliminated. Monetary policy
should reduce the gap between the quarterly average growth rate of
M: 1 and the quarterly average growth rate of the real GNP by onehalf percent per year until rough equality is reached. Congress should
allow for graduated mortgage rates to reduce any short-term adverse
effects of possible increased interest rates as a consequence of tighter
money growth. Management and labor policy in the private sector
must pointly bear the burdens of reducing the demands for price and
wage increases as a strong incentive for the Government to also show
restraint.
Second, in the area of productivity, regulatory policy should set
limits on the cost impact of new and old regulations above which
specific congressional authority would be required before such regulations could be enforced or continue to be enforced. Tax policies
should be reformed so as to encourage business and personal rein vestment in modern plants, new technologies, and export stimulation. Federal research and development policies should accelerate the
national investment in future technologies that are presently beyond
investment capabilities of the private sector.
Third, with respect to unemployment, tax policies should establish
annual permanent decreases in personal and business taxes which
will ( 1) encourage small business development in hiring; ( 2) create
increased long-term demand; and (3) create investment and increase
labor intensive production. Congress should gradually increase the
incentives for able-bodied persons on welfare to seek private sector
employment or training for future private sector employment. Monetary policy should be one of restraint, such as Senator Tower has
advocated, such that business and investment confidence can contribute directly to the creation of private sector jobs. Regulatory and
tax policies should be one of general reduction so that the bottom
rungs of the economic ladder are restored for unemployed youth
and for those with dreams of starting their own business.
Finally, with respect to the export-import balance, regulatory
and tax policies should be one of creating the incentives for production and efficient use of our vast domestic resources of oil, natural
gas, coal, uranium, geothermal, and solar energy so that energy costs
can be driven down by competition and increase domestic supply.
Research and development policies should be aimed at creating higher
efficiency and minimal environmental impact on energy use and eventually making this country a net exporter once again of clean, lowcost energy and energy technology. Congress should create, finally,
a national trade policy coordination commission with the mandate to
help coordinate the trade-related policies of various Federal agencies
which are now almost completely uncoordinated so there can be a
strategic capacity in the U.S. trade policy.
Chairman Miller, I realize that many of the things I have mentioned are beyond the purview of the Fed. However, they are not
beyond the purview of the Federal Government of which the Fed is
a part, and I hope that in your testimony and in your future communications with me and with this committee that we can use these
types of hypothetical policies at the present time as a basis for discussion to see if there can't be a coordinated attack on the four problems I have mentioned.
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I look :forward to hearing your testimony and your comment.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Morgan.
Senator MoRGAN. Thank you, Mr. Chairman.
Mr. Miller, I know I have a lot of problems but no solutions, so
I'm just going to wait for your solutions this morning.
The CHAIRMAN. Senator Sarbanes.
Senator SARBANES. I have no statement.
The CHAIRMAN. Mr. Chairman, go right ahead.
STATEMENT OF G. WILLIAM MILLER, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. MrLLER. Mr. Chairman, I submitted, yesterday morning, copies
of my prepared statement that reviews the economic situation and
the ranges :for the monetary aggregates which have recently been
established by the Federal Open Market Committee.
It's a pleasure for me to be here this morning in my first official
appearance at monetary oversight hearings before your committee.
I welcome this discussion and look :forward to the opportunity in
the future to carry on our dialog and to cover the very important
matters which you and others have already mentioned.
Rather than read my testimony, I thought I might just highlight
its points. Perhaps that would be helpful as an introduction to what
I hope will be a chance :for questions and answers during which we
can get at the matters on your mind and the ones I have on my mind.
Just to set the stage, I think we are all aware that the economy is
currently coming back very strongly from a weak first quarter that
was much influenced by the weather and the coal strike. Employment
has been growing steadily, and unemployment has been edging down.
I have prepared some charts which are attached to my testimony.
On chart 1, we can see the relationship of the growth of real GNP
to the growth of employment since 1974. As you· know, we now have
the highest percentage of our adult population employed that we
have ever had; and the unemployment rate has been coming down.
The consumer sector of the economy continues to show promise of
further gains. Chart 2 shows the performance of retail sales over the
last few years; and, as an indication of whether those sales will continue, two measures of consumer attitudes. The conference board
index shows that consumer confidence continues to be strong. The
Michigan survey index continues to be at a high level, although
yesterday it was announced that there was a dropoff in the level of
consumer sentiment in the Michigan survey of households.
In addition to the consumer sector, I have been very interested, as
you know, in investment activity. In terms of nonresidential fixed
investment, we have had a continuing cyclical recovery. On chart
3, we can see how, during the current cycle, nonresidential fixed
investment, on an indexed basis, has been recovering. The thing that
has concerned me, however, is that the current cycle is still lagging
behind the patterns of previous economic cycles and that it has not
yet returned, in real terms, to the level of investment of its prior
peak.
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On the other hand, contracts and orders for plant and equipment
continue to grow. I did not have this information in my prepared
statement because it was only reported yesterday that orders for
machine tools hit a new high, which is encouraging.
The problem with this otherwise rather encouraging outlook for
the economy, however, is that inflation has worsened and, as I have
noted before, since my nomination the actual performance of various
price indexes and the outlook for inflation have become much worse
than I expected. If you will look at chart 4, you can see the earlier
progress we made in bringing down inflation, using various price
measurements, but that we have suddenly seen a significant increase
in the first quarter of this year. Wholesale prices rose at 9.6 percent
in the first quarter. Consumer prices also increased at an accelerated
pace. And so inflation has become a matter of considerable concern.
In particular, it's of concern that last year compensation per hour
in the private business sector increased at 9 percent, while productivity increased at only 2.5 percent. So we have had a significantmore than a 6-percent-increase in unit labor costs, which is a matter
of real concern.
While we have been seeing the inflation situation worsen, Government actions have been adding to the problem. Something that needs
to be considered is ways in which the Government can start a
deceleration effort to counter the trends toward higher prices and
lower real incomes.
The decline of the dollar is also relevant in discussing this particular period. On chart 5, you can see the tremendous expansion in
our merchandise trade deficit, which reached a record in 1977 and
widened considerably further in the first quarter of 1978. This has
been one of the factors contributing to the decline in the tradeweighted value of the dollar-which is shown in the lower panel on
chart 5. And the decline of the dollar has itself been inflationary,
since the 'lower value of the dollar has increased the cost of our imports and has released competitive pressures in our markets that
have accelerated the general trend of inflation. The decline of the
dollar since last September probably will have added, by the end
of this year, about three-quarters of a percent to the inflation rate;
so it, too, is a matter of concern.
Since last fall, the trade-weighted value of the dollar had dropped
about 8.5 percent through the end of March. But I am encouraged by
the fact that in recent weeks we have seen a strengthening of the
dollar. Even since this chart was prepared, the dollar has recovered:
On a trade-weighted basis, it is back where it was at the beginning
of the year, which is an encouraging development.
In the face of all this, the President has introduced an antiinflation program, a deceleration program. It's a broad program, and
I hope that the President will find support for the steps he's initiated.
I hope that all of the sectors of the economy, public and private, will
join in a combined effort to take concerted action toward reducing the
rate of inflation.
In the past year, there have been increases in interest rates. Longterm interest rates have gone up one-half to three-quarters of a
percent. Monetary policy has been adjusted during this period to
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try to restrain the undue growth in the monetary aggregates. If you
will look on the last two charts, you will note the ranges established
by the FOMC over the last year and the actual growth in the
aggregates.
For most o:f the current cyclical expansion-going back to 1975the growth o:f M 1 was well within the FOMC ranges, but in 1977,
as you can see on chart 6, there was a general tendency £or M1 to
exceed the growth ranges established by the FOMC. These charts
are designed so that you read from the bottom up; the solid lines
show the actual level o:f M 1 and the dotted lines show the ranges
established quarterly, starting at the bottom with the first quarter o:f
1977 and in each case projecting £or a year. The ranges established
at the beginning o:f 1977 indicated a desire :for a maximum growth
o:f M 1 o:f 6½ percent; the actual growth was 7.3 percent. Since that
time, there's been better performance, and so :far in 1978 the aggregates have stayed within the ranges.
On chart 7, you see comparable data as to M2, and here performance has been better. M 2 has actually stayed within the upper limits
o:f its growth ranges for most o:f the period; and now, in the early
part o:f 1978, it is in the lower part o:f the growth ranges established
for this particular measure.
Senator ScHMITT. Mr. Chairman, just quickly, what are the limits
o:f error on the measurement o:f actual value o:f M 1 and M 2? Do you
know that offhand?
Mr. MILLER. The figures, o:f course, are corrected once benchmarks
are established ; so the figures going back through 1977 are now accurate figures.
Senator ScHMITT. Plus or minus what?
Mr. MILLER. Our experience has varied. Steve?
Mr. AxILROD. O:ften, an annual figure might be revised by plus or
minus a half percent, something like that. These figures have been
ben~~marked through September so you wouldn't expect substantial
rev1s10n.
Senator SCHMITT. But you believe their accuracy is plus or minus
half a percent?
Mr. MILLER. Yes. The benchmarks are done, Senator, on a quarterly
basis, to pick up nonmember institutions. Last year, there was a delay
in benchmarking because the data that we get from other institutions
had not been edited, and because o:f the technical problems in getting
accurate information. We skipped a number o:f quarters; the recent
revisions were a catchup.
The program is set up now so we will be getting those benchmark
adjustments accurately on a quarterly basis which will help us make
sure that the figures you see are as up to date as possible.
With credit demands strong, the liquidity o:f banks and thrifts
has come under some pressure. Commercial banks have moved out of
some o:f their securities in order to gain liquidity for making loans.
There's been a slowdown in the flow o:f funds to thrift institutions,
which could affect mortgage lending at some point. So far, with the
greater stability we have today in thri:ft institutions because o:f both
their longer term deposits and their access to nondepository sources of
:funds, we do not expect serious credit difficulties. Credit remains
generally ample.
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As to the ranges £or the cpming year, the new ranges established for
the first quarter 0£ 1978 through the first quarter 0£ 1979 are the
same as the ranges shown on charts 6 and 7 for the fourth quarter
0£ 1977 through the fourth quarter 0£ 1978. The FOMC recently reestablished these ranges: 4 to 6.5 percent £or M1 over the next £our
quarters; 6.5 to 9 percent for M 2 ; and 7.5 to 10 percent for Ma.
Your chairman has pointed out to me that it would be appropriate
to adopt a range £or bank credit, which £or some reason was not
included in· the past. You will note that in my formal testimony I
have indicated our range for bank credit to be 7.5 to 10.5 percent over
the four quarters ahead.
The ranges that have just been adopted contemplate that actual
monetary growth in 1978 and early 1979 will be slower than last
year. Because there have been signs 0£ resurgence in M1 growth over
the last £ew weeks, the Federal Reserve has recently been less accommodative in supplying reserves in order to keep monetary growth
within reasonable bounds over the long run. The money market,
in consequence, has tightened a bit over the past £ew days.
Chairman Proxmire, you indicated that this tightening is 0£ concern to you. It's 0£ concern to me when it's necessary to see a tightening in the money markets, but failure to tighten would mean that
we would unleash the potential £or greater inflation downstream.
When we see the money growth figures jumping ahead too rapidly,
I think we have no responsible choice but to begin to counter this
trend so that we don't £eed inflation in a £ew quarters later.
It was the consensus 0£ the Federal Open Market Committee that
expansion 0£ monetary and credit aggregates within these ranges
would be consistent with moderate growth in real GNP over the
coming year and with some further decline in the unemployment rate.
However, upward price pressures remain strong, and the rate 0£
increase in the average price level, therefore, might be somewhat more
rapid over the year ahead than it was in 1977.
Full and effective public support 0£ the administration's antiinflation program, and success in keeping the budget deficit under
control, would aid in restraining upward pressure on prices and
would help create conditions whereby we could look forward to a
gradual deceleration 0£ the inflationary process.
Let me supplement the FOMC's views with my own outlook £or the
economy in quantitative terms. My personal expectation is that, over
the year ending the first quarter 0£ 1979, real GNP will increase at a
rate 0£ 4¾ to 5 percent; unemployment will drop to the 5¾- to 6percent area, and the GNP price deflator is likely to rise at a 6¾to 71/4-percent rate. It's hardly necessary to add that quantitative
projections such as these are necessarily subject to considerable margins 0£ uncertainty. They must be reevaluated as conditions in the
economy change and as we have real data on which to base our
judgments.
Specifying growth rates for the monetary aggregates, too, is subject
to considerable uncertainty. The growth in the narrowly defined
money supply, M 1, needed to support economic expansion, depends
in part on changes in velocity, and this sometimes is hard to predict.
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The behavior of the broader aggregates, ~ 2 and M 3 , will be affected
a year ahead also by the constraint placed on the ability of depository
institutions to attract funds under existing regulatory ceilings on
interest rates.
The Federal Reserve believes that its determination to hold monetary growth within the ranges just adopted will work to curb inflation over the longer term and at the same time provide adequate
money and credit for continued economic growth. However, under
current conditions, when inflationary pressures are to a great extent
embodied in the structure of the economy, any deceleration in monetary growth rates has to be undertaken with caution. The pace of
deceleration cannot proceed much more rapidly than the pace at
which built-in inflationary pressures are wrung out of the economy
if satisfactory economic growth is to be maintained. Thus, bringing
inflation under control urgently requires the cooperative efforts of
the administration, the Congress, the Federal Reserve, and the private
sectors of the economy. The Federal Reserve should not be left to
combat inflation alone. Thank you, Mr. Chairman.
[Complete statement follows:]
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Statement by
G, William Miller
Chairman, Board of Governors of the Federal Reserve System
Mr. Chairman, members of the Committee, it is a pleasure
to meet with you and to report, on behalf of the Board, about the
outlook for the national economy and about the course the Federal
Reserve has charted for monetary policy over the year ahead.
I
look forward to a continuing dialogue with you on these matters at
this Committee's regular monetary oversight hearings.
ECONOMIC ACTIVITY IS REBOUNDING
The economy is currently rebounding from a slack period
early in the year when economic activity was constrained by severe
weather and the long coal strike.
Retail sales and industrial
production have risen sharply since mid-winter,
strengthened,
Auto sales have
Housing starts i~creased markedly in March from the
relatively depressed levels of January and February.
Employment has grown steadily since the beginning of the
year.
Although the -length of the average workweek declined in the
first quarter, the number of people on the nation's payrolls rose
substantially between December and March, and the unemployment rate
edged down from 6.4 to 6,2 per cent.
These favorable trends in the
labor market are depicted, along with the behavior of real gross
national product, in the attached chart 1.
The continuing uptrend in
employment suggests that businessmen have had sufficient confidence
in the underlying strength of the economy to be positioning themselves for further increases in production.
Looking ahead, growth in economic activity is expected to
be sustained over future months by expanding consumer and business
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Federal Reserve Bank of St. Louis
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demands.
As shown in chart 2, the near-term prospects for good
gains in consumer spending appear favorable, as indexes of consumer
sentiment have remained at high levels.
Business spending also should provide impetus to expansion.
Inventories generally remain lean, and businesses are likely to be
building their stocks in the next few quarters.
Business investment
in plant and equipment, after lagging early in the economic upswing,
has increased at a good pace over the past two years, as shown in
the upper panel of chart 3.
Surveys of capital spending plans and
other advance indicators suggest at least moderate further growth in
the year ahead.
Although State and local governments by and large continue
to pursue cautious financial policies, they also may register significant increases in real expenditures in the period ahead,
Residential
construction should show sizable increases in the next few months
before tapering off gradually in the second half of this year.
And
the foreign trade deficit, while remaining large, should moderate
somewhat from the very high first quarter rate.
BUT INFLATION HAS WORSENED
While the prospects for economic activity thus appear to
remain favorable, there are other aspects of recent economic performance that reflect fundamental problems which will not be put
behind us quickly.
Inflation undoubtedly is the most troubling of
these to the American people.
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Even as growth in real GNP was
135
interrupted in the first quarter, the rate of increase in prices
accelerated.
Wholesale prices rose at a 9.6 per cent annual rate
during the past three months--well above the already uncomfortably
high rates experienced last year.
accelerated.
Consumer price increases also
To be sure, a substantial spurt in volatile food prices
contributed importantly to the advance in the broad price indexes, but
prices of industrial commodities and of services also have continued
to rise at a brisk pace.
These unfavorable trends in prices are
displayed in chart 4.
UPWARD COST PRESSURES REMAIN
There is little reason to be optimistic about the likelihood
of achieving a significant reduction in underlying inflationary forces
in the near future.
Cost pressures remain strong.
In 1977, for
example, total compensation per hour in the private business sector
rose almost 9 per cent, while productivity increased only 2\ per cent;
as a result, unit labor costs rose more than 6 per cent.
There has
been no sign of any abatement of the advance in wage rates, and at
this stage of ~conomic expansion there is little likelihood of a
sustained pick-up in productivity growth.
Therefore, rising unit
labor costs can be expected to continue to exert considerable upward
pressure on·prices.
GOVERNMENTAL PROGRAMS HAVE ADDED TO COSTS AND INFLATION
Price pressures have been exacerbated by governmental
actions.
Certain tax actions, while they have helped to reduce the
budgetary deficit and in this way have worked to restrain one of the
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forces feeding inflation, simultaneously have added to labor costs.
This has been the case, for instance, with increases in employer
contributions for social security and unemployment insurance,
Some
other governmental actions also have added to inflationary forces
without any compensating restraint.
In this class are the increase
in the minimum wage, agricultural price supports, and various import
restrictions.
In general, there has been a tendency by government
over the years to treat the problems of individual sectors without
adequate regard to the cumulative inflationary bias the programs have
imparted to the economy.
• • SO TOO HAS THE DECLINING INTERNATIONAL VALUE OF THE DOLLAR
Another disturbing aspect of economic performance in
the opening months of this year has been the pronounced widening
of the foreign trade deficit and the weakness of the international
value of the dollar.
As may be seen in chart 5, the estimated trade
'deficit was greatly enlarged in the first quarter of 1978, as exports
remained sluggish and imports in nearly all categories increased
sharply.
Against this backdrop, the dollar declined on exchange
markets, and by the end of March its trade-weighted value against
other major currencies was 8\ per cent lower than early last fall.
The depreciation of the dollar is tending to raise the domestic price
structure in various ways: higher prices of imported finished goods
raise directly the prices paid by consumers; higher prices of
imported materials raise the costs of domestic manufacturers; and
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Federal Reserve Bank of St. Louis
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higher prices of foreign goods reduce the pressure to hold down
prices of the domestically produced goods with which they compete
in our markets.
In recent weeks, the dollar has risen relative to other
major currencies.
Such a trend, if continued, will help moderate
inflationary pressures.
THE PRESIDENT'S ANTI-INFLATION PROGRAM OFFERS HOPE OF BREAKING
INFLATIONARY PSYCHOLOGY
President Carter recently outlined a broad program to help
deal with the problem of inflation. The Federal Reserve welcomes this
initiative.
Given the ~upport of the Congress and of the general
public, the program is a constructive step toward breaking the
inflationary patterns and psychology that today are so firmly
entrenched.
The job of containing inflation requires a concerted
effort on the part of all Americans.
The Federal Reserve will
play its part in supporting the President's initiative by exercising
appropriate restraint in the provision of bank reserves, credit, and
money.
The prospects for inflation will play a major role in
shaping future financial developments.
The strength of the dollar
on foreign exchange markets is influenced by expectations about
inflation.
So, too, is the level of interest rates in domestic
credit markets.
The increase in interest rates during the past
12 .months--especially the
~
to
1
percentage point increase in
long-term bond rates--may be attributable in part to heightened
inflationary expectations.
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MONETARY POLICY HAS BEEN ADJUSTED TO RESTRAIN UNDULY RAPID
MONETARY GROWTH
Yields on most short-term market instruments today are
about ll to 2 percentage points higher than a year ago.
This rise
occurred gradually as the Federal Reserve adjusted its policies in
light of the tendency for monetary expansion to exceed the growth
ranges that had been established.
The tendency was most pronounced
in the case of the narrow money stock, M-1, which includes only
currency and demand deposits.
Largely as a result of the rapid
expansion of M-1, however, growth in the broader monetary aggregates
--M-2 and M-3--also remained near the upper ends of their ranges.
M-2 is M-1 plus time and savings deposits at commercial banks (other
than large negotiable certificates of deposit), while M-3 includes
also time and savings deposits at thrift institutions.
For most of the current cyclical expansion, growth in M-1
had been well within the ranges established by the Federal Reserve.
Indeed, early in the expansion, growth was near the low end of the
range.
In part, this was the result of actions by the public to
shift funds from demand deposits to interest-bearing savings deposits
and market instruments in response to financial innovations that made
it easier to transfer funds in and out of savings deposits.
In part,
it seems to have reflected a lagged response to the unusually high
level of interesf rates reached during the 1973-74 inflation.
And,
in part, it may also have reflected the return of confidence during
economic recovery, which made the public more willing to spend out
of existing cash balances and thus reduced the need for the Federal
Reserve to supply additional money to the economy.
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By last year, the moderating impact on money growth of
such factors had considerably lessened,
Moreover, persisting
upward cost and price pressures were making it difficult for the
Federal Reserve to hold money growth within bounds while not risking
undue interference with continued economic expansion.
Finally, it
is possible that the public earlier had reduced its cash balances to
unsustainably low levels relative to income, and that some part of the
sizable expansion in money last year reflected a restoration of cash
balances to more normal levels.
MONEY GROWTH HAS SLOWED
Growth in the monetary aggregates slowed during the
latter part of 1977 and in the early months of 1978.
As can be
seen in charts 6 and 7, M-1 has moved back within the FOMC's ranges,
while M-2 has moved from the upper limits of the ranges toward the
lower limits.
M-3 has behaved about the same as M-2.
This moderation
of monetary expansion has reflected in part the cumulative impact of
the restraining actions and rise of short-term interest rates that
began in the spring of last year. The influence of interest rates has
been most evident in the case of the interest-bearing components of
the monetary aggregates.
As market rates of interest rose relative
to deposit rate ceilings, some savers shifted their funds from
deposits at banks and nonbank thrift institutions into market instruments, in the process contributing to the slowing of M-2 and M-3
growth.
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WITH CREDIT DEMANDS STRONG, LIQUIDITY OF BANKS AND THRIFTS HAS
COME UNDER PRESSURE
The slowing of monetary expansion in recent months, in
conjunction with strong credit demands, has been accompanied by
some erosion in the liquidity of depository institutions.
To finance
business, consumer, and mortgage credit demands, commercial banks
have turned increasingly to the short-term credit mark;ts as a
source of funds.
There has been marked growth in the outstanding
volume of large-denomination time deposits, which are not subject
to regulatory interest rate ceilings, and in the nondeposit interestbearing liabilities of banks.
At the same time, banks have appreciably
reduced their holdings of Treasury securities.
Despite these changes
in bank portfolios, however, customary measures of bank liquidity
still indicate more comfortable conditions than prevailed a few years
ago.
Thrift institutions, with the exception of credit unions,
have experienced much the same pressures as commercial banks, as
mortgage loan demand has remained strong.
To accommodate that demand,
institutions--in particular, savings and loan associations, which
are the largest home mortgage lenders--have borrowed heavily from
Federal Home Loan Banks and curtailed their acquisitions of securities.
The S&L's have also utilized other sources of funds,
including the growing markets for private mortgage-backed bonds and
mortgage pass-through securities, to sustain new mortgage lending.
These markets promise ultimately to give thrift institutions greater
flexibility in managing their portfolios, and to make the residential
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mortgage market less dependent on thrift institutions' deposit
flows.
At present, however, with deposit flows running weaker and
liquidity coming under pressure, S&L's have cut back on the outstanding volume of loan coaunitments since year-end.
And mortgage
interest rates have risen moderately in recent months.
CREDIT REMAINS GENERALLY AMPLE 2 HCMEVER
Despite the greater pressures experienced by depository
institutions, credit generally remains in ample supply.
Borrowers
are experiencing little difficulty in raising needed funds at
current interest rate levels.
And while higher than a year ago,
interest rates are at relatively modest levels after allowance is
made for the effect of inflation.
MONETARY GROWTH RANGES FOR YEAR AHEAD ARE EXPECTED TO SUPPORT
FURTHER ECONOMIC EXPANSION AND A LOWER UNEMPLOYMENT RATE, BUT
INFLATION MAY NOT DECELERATE UNTIL LATER
The ranges of monetary expansion adopted by the Federal
Open Market Connnittee. for the year ending with the first quarter of
1979 reflect our belief that growth in the monetary aggregates should
be moderate, with credit remaining in reasonably good supply.
The
Coaunittee has specified a growth range for M-1 of 4 to 6~ per cent.
For M-2, the range selected is 6~ to 9 per cent, and for M-3, 7~ to
10 per cent.
These ranges are the same as the Cormnittee had earlier
specified for the year ending with the fourth quarter of 1978.
Although the FOMC at this time has not made a further reduction in
its monetary growth ranges, the Coaunittee remains firmly coaunitted
to a gradual reduction in monetary growth over time to rates more
28-083 0 - 78 - 10
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nearly consistent with reasonable price stability.
The ranges just
adopted in fact contemplate that actual monetary growth in 1978 and
into early 1979 will be slower than last year.
Because there have
been signs of a resurgence in M-1 growth over the last few weeks, the
Federal Reserve has recently been less accommodative in supplying
reserves in order to keep monetary growth within reasonable bounds
over the long run.
The money market in consequence has tightened a
bit over the past few days.
In addition to adopting ranges for the monetary aggregates,
the FOMC also adopted an associated range for bank credit that
projects an increase between 7\ and 10~ per cent over the one-year
period ahead.
Such a range would allow for continued expansion in
bank credit at around its recent pace.
It was the consensus of the Federal Open Market Committee
that expansion of monetary and credit aggregates within these ranges
would be consistent with moderate growth in real GNP over the coming
year and with some further decline in the unemployment rate.
However,
upward price pressures remain strong, and the rate of increase in the
average price level, therefore, might be somewhat more rapid over the
year ahead -than it was in 1977.
Full and effective public support
of the Administration's anti-inflation program, and success in
keeping the budget deficit under control, would aid in restraining
upward pressute on prices and would help create conditions whereby
we could look forward to a gradual deceleration of the inflationary
process.
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Let me supplement this with my own views about the outlook
for the economy in quantitative terms.
My personal expectation is
that, over the year ending with the first quarter of 1979, real GNP
probably will increase in a 4\ to 5 per cent range, the unemployment
rate probably will drop into the S! to 6 per cent area, and the GNP
price deflator is likely to rise by 6! to 7\ per cent.
It is hardly
necessary to add that quantitative projections, such as these, are
subject to considerable margins of uncertainty.
Necessarily they
have to be re-evaluated on the basis of incoming economic data and
changing conditions here and abroad.
Specifying growth rates for the monetary aggregates, too,
is subject to considerable uncertainty.
The growth in the narrowly
defined money supply (M-1) needed to support economic expansion
depends in part on changes in the velocity of money--that is, on the
rate at which the public uses the existing stock of money to finance
transactions.
Velocity may rise rapidly or slowly, depending on
shifting public preferences for demand deposits as compared with
other assets and on the state of consumer and business confidence.
The behavior of the broader aggregates--M-2 and M-3--will
be affected in the year ahead also by the constraint placed on the
ability of depository institutions to attract funds under existing
regulatory ceilings on deposit rates.
If heavy demands for money
and credit should place further upward pressure on market interest
rates, deposits subject to regulatory rate ceilings will be placed
at a substantial competitive disadvantage.
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144
growth of M-2 and M-3 could fall short of the ranges set by the
FOMC, unless there are upward adjustments in the ceiling rates on
some or all categories of time and savings deposits.
FEDERAL RESERVE SHOULD NOT BE LEFT TO COMBAT INFLATION ALONE.
EFFECTIVE ANTI-INFLATION PROGRAM REQUIRES CO-OPERATIVE EFFORT
The Federal Reserve believes that its determination to
hold monetary growth within the ranges just adopted witl work to
curb inflation over the longer run and at the same time provide
adequate money and credit for continued economic growth.
However,
under current conditions--when inflationary pressures are to a
great extent embodied in the structure of the economy--any deceleration in monetary growth rates has to be undertaken with caution.
The pace of deceleration cannot proceed much more rapidly than
the pace at which built-in inflationary pressures are wrung out
of the economy ,if satisfactory economic growth is to be maintained.
I
Thus, bringing inflation under control urgently requires the
co-operative efforts of the Administration, the Congress,, the Federal
Reserve, and the private sectors of the economy.
The Federal
Reserve should not be left to combat inflation alone.
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Ch•rt 1
OUTPUT, EMPLOYMENT, AND UNEMPLOYMENT
BILLIONS OF 1972 DOLLARS
REAL GNP
1400
1300
1200
1974
1975
1976
1977
1978
MILLIONS
TOTAL EMPLOYMENT
82
78
1974
1975
1976
1977
1978
PER CENT
UNEMPLOYMENT RATE
8
6
4
1974
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1976
1977
1978
146
Ch ■ rt
2
CONSUMER SECTOR ACTIVITY
BILLIONS OF DOLLARS
70
RETAIL SALES
60
50
1974
1975
1977
1976
1978
INDEX
CONSUMER ATTITUDES•
100
Conference Board
---
, ........
___
80
Michigan Survey
60
40
1974
1975
1976
• Conterence Board ind•• of conaum.r confidence. 1969-70 =100,
Michigan survey Index ot COffl;umet untiment. 1966 01=100.
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1978
147
Chart 3
BUSINESS CAPITAL SPENDING ACTIVITY
INDEX, TROUGH QUARTER=too
NONRESIDENTIAL FIXED INVESTMENT
1972 Dollars
Average of
___
Five Previous Cycles
/,.__ ....
_,.,,,, .,....
,..
,,..,,..
,,,. /
.,,,.,,,, ~
120
/
//
_
110
_,,.,,,,
100
1974
1975
1976
1977
1978
BILLIONS OF DOLLARS
CONTRACTS AND ORDERS FOR PLANT AND EQUIPMENT
1972 Dollars
14
12
10
1974
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1976
1977
1978
148
Chart 4
MEASURES OF AGGREGATE INFLATION
-
-
PERCENTAGE CHANGE FROM PREVIOUS PERIOD, ANNUAL RATE
GROSS DOMESTIC BUSINESS PRODUCT
Fixed-Weighted Price Index
~
'
-
-
9
-
6
-
3
!
I
-
I
-
I
I
1975
1976
01
1977
1978
-
CONSUMER PRICES
All Items
- 9
~
January February
averaQe
- 6
~
I
I
I
i
1111
!!ii I
- 3
' I
~
11
1975
,.
I
I
1976
1977
01
1978
PRODUCER PRICES
Total Finished Goods
9
6
3
1975
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1977
01
1978
149
Chari 5
INTERNATIONAL SECTOR ACTIVITY
BILLIONS OF DOLLARS
MERCHANDISE TRADE
160
120
1974
1975
1976
1977
1978
INDEX, MAY 1970=100
FOREIGN EXCHANGE VALUE OF
THE U.S. DOLLAR*
95
85
75
1974
1975
1976
1977
*we1gMed average aga,nst G·lO countries plus Switzerland using total 1972 trade ot these countnes
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150
Chart e
RECENTLY ESTABLISHED M-1 GROWTH RANGES AND ACTUAL M-1
BILLIONS OF DOLLARS
360
---
___ . ,,.
350
340
l
l
350
340
320
310
350
Q3 '77-Q3 '78
340
350
340
330
310~~-~~--'-~--'-~--'-~-----'---'---'-------'----'-------'----'------'---'--....L-'--....L--'-....L--'-...J
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151
Chart 7
RECENTLY ESTABLISHED M-2 GROWTH RANGES AND ACTUAL M-2
BILLIONS OF DOLLARS
880
860
840
820
]840
]820
7840
]820
760
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840
820
t977
1978
152
The CHAIRMAN. Thank you, Chairman Miller.
This month and probably this quarter we can expect a snapback
from the slow performance of the economy in the first quarter. During
the last several quarters the growth rate of the real GNP has declined.
The growth rates for the monetary aggregates have declined also,
as indicated on the first chart there to your extreme right. It's obvious-and let me just go on to say thrift deposit flows have declined
and the Federal fund rate has increased by almost 2¼ percentage
points which is a very sharp increase. It's obvious from the charts
that increases in interest rates, slow monetary growth with a lag,
but not immediately.
Given all this, Mr. Chairman, how do you justify the recent further
increases in the Federal funds rate and what does the Federal Reserve
expect to accomplish by this move?
Mr. MILLER. Mr. Chairman, the recent tightening is in response
to the increased rate of growth in the monetary aggregates that has
been noted in recent weeks. During the first quarter of the year, the
aggregates performed very well, and the Federal Reserve was able
to maintain a steady state without any significant changes in rates;
this was a very reassuring condition.
However, as the second quarter has unfolded, there has been a jump
in economic activity; this, of course, is partly because of the snapback
of economic activity from the depressed first quarter. And so there
is a risk that the rapid expansion of money could feed some inflationary forces into the economy. I think it's important that the Federal Reserve react steadily, but promptly, and do so with restraint as
I have mentioned. But we do need to lean against this situation so
that we demonstrate to the world that for our part we are exercising
the discipline which, when coupled with discipline from the fiscal
side and with other efforts to curb inflation, will keep us on a course
where we can grow and avoid any interruption of our economic
expansion cycle.
The CHAIRMAN. Well, there are a couple of problems I have with
that explanation. You indicated at the beginning you recognize unemployment was unacceptably high and we have to do more to diminish unemployment; we have to have policies that will do that. I think
you would acknowledge that the economy did slow down quarter by
quarter last year right into the last quarter. Your explanation for
your reaction has been that the money aggregates increased rather
~harply in the last brief period. If you look at the top chart over
here you can see how terrible the performance of the Federal Reserve
has been in terms of staying within the targets, the 2-month targets.
The actual growth rates, as you can see marked by the solid black
figure, have been -far different than what you have been able to achieve.
On the basis of this, it seems to me that your short-term forecasts
haven't been very reliable and that a more sensible policy would be
as was recommended to us unanimously by the witnesses who testified
yesterday, that the action in pushing the Federal funds rate up to
7 percent was premature.
Mr. MILLER. Senator, I think what your chart shows is correct.
It is very difficult to control the monetary aggregates in the very
short run. One of the misconceptions people have is that this is
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Federal Reserve Bank of St. Louis
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somehow something that can be maneuvered on a weekly basis; I don't
believe that's true. We are all looking at the wrong targets when we
set these very short-term ranges and expect to fall within them.
,vhat we should be looking at is how we control the aggregates over
the longer term. That's why I said to you that the rather prudent action by the Federal Reserve of a slight tightening is designed not as
a sort of knee-jerk operation or out of some sort of impetuousness,
but rather to lean in the direction of making sure we keep the aggregates within our ranges over the longer run. This, to me, makes more
sense. I'm not suggesting to you that because of a short-range jump
in the aggregates we are suddenly taking precipitous action. If we
did that, if we took precipitous action, then in the first quarter we
could see interest rates drop off very rapidly because the aggregates
were performing very well; and in the second quarter, we could suddenly run the interest rates up to enormous numbers. So we are not
trying-at least I don't want to try-to manage the money supply
on a weekly basis. I wish that we would get away from the habit in
this country of looking at those money supply figures every Thursday
and assuming that the world was going up or down on a weekly basis.
But I do think it's very important that we show a prudence, a soundness, in recognizing the longer trends and that we make sure to lean
and to guide the ship so that we do stay within the ranges that make
sense.
The CHAIRMAN. What are your money growth expectations for the
next two quarters?
Mr. MILLER. The ones that we have just recited. We, of course, are
looking for an M 1 growth of 4 to 6-½ percent.
The CHAIRMAN. I'm talking about the next two quarters, not the
next year.
Mr. MtLLER. We have not set any ranges for two quarters. The
policy, as you know, has been to set two-month ranges.
The CHAIRMAN. I understand. I'm not asking for the target. That
is a year, I understand. I'm asking for your projections, your expectations for the next two quarters.
Mr. MILLER. My expectation is to do the best we can, depending
on how the economy is performing, to maintain the growth of these
monetary measurements within the ranges we have presented to you.
The CHAIRMAN. And what do you expect? Do you expect any particular difference in the next two quarters in terms of economic activity as compared with what you have already explained to us for the
next year? Do you expect the next two quarters to be fairly strong?
I'm talking about the third and fourth quarter of the year.
Mr. MILLER. Senator, you bring up a very good point. Maybe it
would be helpful if I just pause for a moment. My figures for growth
in the next four quarters-my personal figures you must realize-take account of what I would imagine to be a very strong second
quarter. Therefore, my view is that the economy is going to show a
slower rate of growth, but still a very satisfactory rate of growth, in
the third and fourth quarters. There's going to be a 6½ to 7 percent
real growth in GNP in the second quarter, a distorted growth because
of the push forward from the first quarter. We can expect, as the
year goes forward, to be getting back on to the more normal path
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Federal Reserve Bank of St. Louis
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that we would have been on had the first quarter been normal and
the second quarter been normal. Under such circumstances, it would
be very pleasant if the monetary aggregates begin to fall within our
ranges and the pressure that we feel in managing the situation
under the present, rather stimulative conditions, is eased up.
The CHAIRMAN. Well, you expect a big snapback in the second
quarter, and I think that seems to be a fairly strong consensus views percent to 8½ percent, something like that, real growth, with how
slow a third and fourth quarter 1
Mr. MILLER. I would think that the growth rate in the second
quarter would not be quite that strong. My own guess is a 6½- or 7percent real growth in the second quarter, and thereafter I would
think a growth rate nearer the 4-percent level.
The CHAIRMAN. Now the Humphrey-Hawkins bill under the several different versions would have the President report annually
numerical targets each year for real gross national product, employment, unemployment, real income, and price. These would be the
ultimate objectives of Government economic policy. We don't have
quantitative goals now, as you know, but the Employment Act of
1946 includes these broad objectives in qualitative form.
How are the Federal Reserve policies consistent with the Nation's
clear need to reduce unemployment and inflation at the same time 1
Mr. MILLER. The only way we can be sure that we have full employment is to be sure that we have lower inflation; the two are
coupled very closely together. I don't believe we can have low unemployment with high inflation, nor do I believe we can have low
inflation with high unemployment. So I think they are coupled
together.
The reason that I have been particularly concerned with the inflation situation in the last 6 weeks since I have been in office is because
I found it worse than I expected. Since unemployment has been at
a level as low or lower than planned and since the inflation rate has
been higher than planned, I felt it extremely important that we work
on bringing inflation back under control. If we do that, we wi:11 en courage business investmen~, job creation, productivity gains, and real
growth in the economy. If we fail to do that, inflation expectations
and actualities will result in a dropoff in business investment, a dropoff in housing, a slowdown of the economy, and higher unemployment. So my concern with and focus on inflation is for the very purpose of creating conditions whereby we can control inflation, generate
jobs, and reduce unemployment.
The CHAIRMAN. My time is up. Before I yield to Senator Tower,
let me say I wholeheartedly agree with the primacy of the inflation
problem right now. I feel that we have to do a far better job on the
fiscal front. That's why I've got an amendment cutting the budget
by $25 billion. I'm going to call it up this afternoon. But I still think
that monetary policy should be as easy as possible under these circumstances.
Mr. MILLER. Senator, I hope that the fiscal side of the House will do
its job; as I say, I don't want to fight inflation alone. I'd love to come
before you with interest rates dropping and everything fine, but the
way to do that is to balance the budget.
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The CHAIRMAN. My time is np. Senator Tower.
Senator TowER. I want to concur with Senator Proxmire in agreeing with your assessment 0£ the inflationary problem and how inflationary expectations and inflation are themselves the cause 0£ recession. I note in your statement in noting the causes 0£ inflation you
include increases in employer contributions to social security and
unemployment insurance, minimum wage, agricultural price supports,
various import restrictions, and you quite properly noted the tendency by Government over the years to treat the problems 0£ individual
sectors without adequate regard to the cumulative inflationary bias
the program has imparted to the economy. I think we in the Congress
have to bear the lion's share 0£ the responsibility £or that failure
to consider the aggregate impact 0£ what Government does.
In your inflationary £actors there are some that you did not mention-the regulatory burden on the business community which appears
to me to be substantial; the recent coal settlement, what impact that's
likely to have; and the impact 0£ conversion costs, energy conversion
costs are likely to have. It seems to me these are all going to be fairly
whopping £actors. I don't separate out the coal settlement alone because there are problems with wages and benefits outstripping productivity in other sectors as well.
I wonder i£ you could comment on those other £actors that I hav~
mentioned.
Mr. MILLER. Senator Tower, I concur. Perhaps, in an effort to be
brief, I did not include all the £actors that are affecting inflation.
Those you mention are important contributors to inflation; I think
they are far more important than sometimes is recognized. I have
been somewhat encouraged by what I perceive to be possible actions
to deregulate airlines and perhaps some 0£ the trucking industry. I
hope we can be realistic about a whole series 0£ regulatory matters that
add to costs and perhaps don't have any compensating benefits at this
particular time. You may have noticed that in my comment I tried
to distinguish those kinds 0£ inflationary actions by Government
that do have certain social benefits; they have to be weighed carefully.
The social security tax increase is high, but there is a social benefit
to that program. How to be responsible is a tough question. Some
other inflationary actions don't even have any benefits. Some 0£ the
regulatory actions, I think, come out 0£ habits rather than realities;
they are not really necessary. What we need to do is deregulate some
more areas and let the private sector compete more; that's the best
way. Businessmen tend to be pretty aggressive competitors i£ they
are given the chance, and that usually brings the supply side up and
the costs down.
Senator TowER. I was thinking not only 0£ the type 0£ regulation
that impacts on competition but the type 0£ regulation that impacts
on an individual business such as compliance with various Government regulations-occupational safety and health environmental, et
cetera-any one 0£ this range 0£ things that doesn't deal with the
flow 0£ commerce itself.
Mr. MILLER. The other day I heard about one that was illustrative
0£ just what you're saying. I understood there was a regulation from
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Federal Reserve Bank of St. Louis
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OSHA saying that the harvesters of timber-the timber companieswould not be able to cut timber in a tract where hunting was allowed.
·well, in many communities, if you don't allow hunting in t~ose
tracts, I don't think you get much support from the local population,
and somehow a lot of fires start. I can't see why it would be inconsistent with safety to find other ways of making sure, on a more
realistic basis, that hunters can hunt and that we can harvest timber.
Why that regulation is needed, I don't know.
Senator TowER. I think conversion costs are ultimately going to
have a considerable impact on this. That leads me to my next question
and that is my concern over future capital recovery and capital
formation and what our estimated new capital needs are going to be
to maintain a satisfactory rate of economic growth over the next 8
to 10 years, and I just wondered what comments you have on that;
whether you have any estimates of what our new capital needs will
be and our ability to supply those needs over the next few years.
Mr. MrLLER. Senator, there has been a tendency in the postwar
period to manage the U.S. economy mainly by dealing with the
demand side. I think for only one period during the early 1960's was
there significant concentration on the capital investment and supply
side, and that was a period of unusual growth and price stability.
I'm considerably concerned that we have had a lag in capital investment in this cycle. I'm considerably concerned that we are falling
behind other industrialized nations in the percent of GNP we put into
investment. I'm deeply concerned that we do not have adequate
capital formation, and I have felt that, beyond the problems of
unemployment and inflation, the next priority in our economic
planning is to shift our emphasis from consumption and demand to
an emphasis on investment.
The best way and the fastest way and the easiest way and the most
efficient way to do that would be to allow a substantial liberalization
in depreciation. If we could, today, establish for production equipment a writeoff life of 5 years, and for structures used for production
a writeoff life of 10 years, and for commercial ahd office structures a
writeoff of 20 years, we would see a tremendous growth in investment.
We would find employment going up; we would find costs coming
down, and we would open up the best prospect I know of for longterm growth with price stability.
Senator TowER. Well said. Do you have any comment on wage and
price controls?
Mr. MILLER. I am opposed to them.
Senator TowER. Good. Now I have noted in your statement that
cost pressures are persisting because of large wage increases and low
productivity. What do you think could be done to increase productivity?
Mr. MILLER. I think the first thing is increased investment, but
there are many other techniques. We have seen the Jamestown experience. We need to look at a series of techniques. I have found, in
business, that no one technique is always successful because people
are such a key ingredient. I've found and I'm sure you've found that
where there are instnnces of leadership, of involvement, productivity
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gains are enormous. So we know there's a people factor and we know
there's a factor o:f skill training. But ·we have probably done as well
as we can and will probably continue to do as well as we can, on the
mobilization o:f human resources. So I really believe the best gains
in productivity we can make now will come through a substantial increase in investment, in modernization, in cost reducing :facilities, so
that we can get more production per man-hour through the use o:f
more modern equipment.
Senator TowER. You mentioned the recent stabilization o:f the dollar in :foreign exchange markets. What role did monetary policy play
in this stabilization and how do you envision the :future role o:f
monetary policy as a means o:f stabilizing the dollar?
Mr. MILLER. The dollar declined, in my opinion, because o:f :fundamental problems in the balance o:f trade and current account, and because o:f our heavy dependence on imported oil. I believe that the
dollar has been improving because o:f a perception that we are coming
to grips with our problem o:f inflation, and that we are beginning, I
hope, to :face up to the problem o:f imported energy. And as it becomes
clearer that we are serious about these matters, and if the trends are
right, then the :fundamental strength, resiliancy, and productivity of
the American economy will result in a stronger dollar. As a matter o:f
:fact, if we can continue the momentum that has been built recently,
I think the dollar will be considerably stronger, but that is because,
and only because, we will be seen as being effective and dedicated to
addressing the :fundamentals. In that, monetary policy has played a
role by showing that, despite the easier path o:f accommodation we
might have taken, we have been willing to take the path o:f restraint
until the other elements o:f the economy can marshal their :forces and
take up some o:f the burden. The prudence o:f monetary policy actions
has encouraged :foreign holders o:f dollars to see them as more valuable at the moment than was true three months ago.
Senator TowER. Mr. Chairman, Senator Brooke was unable to be
here today but he asked me to express his concern about the erosion
o:f Federal Reserve System membership. Do you have any plans to
help stop this continuing tendency o:f banks to leave the Fed?
Mr. MrLLER. Moving away from monetary policy and inflation to
the banking system, one of my high priorities on this side is to address
the problem o:f membership. There are several reasons why it is o:f
concern. The first is that i:f we are going to do an effective job in
monetary management, then we need the broad-based participation of
banking system in the Federal Reserve network. Second, the tendency
o:f sizable banks to move out o:f the Federal Reserve System may erode
the strength o:f our supervision o:f banks. In these troubled times, it's
important that we have good supervision and that we have dedication to maintaining the soundness and integrity o:f the banking
system.
So there are a lot o:f reasons why I think membership is important.
The reasons the banks have been leaving, as you know Senator Tower,
is because of the burden of membership; it's cheaper to be outside o:f
the Federal Reserve System. We have to address that issue head on,
and the elements o:f addressing it are as :follows: the competitive bur-
28-083 0 - 78 - 11
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den relates to the maintenance of sterile reserves, and we need to provide compensation to banks for maintaining those reserves in the
Federal Reserve System. I don't £eel we should do that, however,
without coupling compensation to a program of explicit pricing for
the services of the Federal Reserve. There are many advantages to
explicit pricing. One is that the services will then be used in relation
to their value. Anything that's free will be abused. Once we get services properly priced, I think the marketplace will tend to see that they
are used efficiently because pricing will encourage banks to look at
their options, at other systems.
So I would like to see the element of compensation for reserves;
I would like to see the element of pricing of services. The Federal
Reserve would pay out something in compensation and it would receive something in charges, and the net between the two would be a
contribution to reducing the burden of membership and would encourage banks to stay within the system.
The third element we need is to manage our program in a way that
doesn't impact the Treasury because, of course, the earnings of the
Federal Reserve go into the Treasury as general revenues. It's very
important that the Federal Reserve maintain its level of contribution
to the Treasury through a transition period so that we don't in any
way impact the Treasury adversely.
I£ we get those three elements, I would like to see us then examine
the possibility of a wider access for nonmembers to some of the
services of the Federal Reserve-for example, to the electronic transfer of funds. It's important that there be a general access to this
service for members, but it's also important that we price this service
so that members aren't paying to provide a payment mechanism free
for others.
Let me add that I have a timetable in mind for a program along
these lines. I would like to see the Federal Reserve, by June, issue a
proposed action plan along these lines. I would like to have that available to you and your committee and other committees of Congress and
to the banking industry and the whole financial industry. I would
like, perhaps, a period of 3 months £or complete discussion, debate,
and examination, after which we could accept your comments and
suggestions and revise the plan. ,vith good fortune, maybe we could
have a plan effective by the first of the year with the objective, in my
mind, of having a pricing mechanism in effect by ,Tuly 1, 1979. This
is the kind of schedule I have in mind.
Senator TowER. Thank you, Mr. Chairman. I apologize £or running
over my time.
Mr. MILLER. I think it's my fault. You asked the question before the
red light, but it's a subject near and dear to my heart. I think it's important, and I thought I would like the chance to tell you my views.
Senator TowER. It is enormously important. We appreciate that.
Thank you.
The CHAIRMAN. Senator Sarbanes.
Senator _SARBANES. Chairman Miller, I am interested in an explanation 0£ the position you have taken with respect to the tax cut proposed, and I'd like to hear you elaborate on that.
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Mr. MILLER. Senator Sarbanes, we have an economy that is in its
fourth year of expansion. By the time the fiscal year 1979 plan is into
its second quarter we will be in the fifth year of expansion, and by
any measure of postwar experience that is a very aged expansion.
With good management, we should be able to continue that expansion,
and I see no need to have a recession if we are wise and prudent in
our management.
On the other hand, I see that we will have a recession or an economic downturn for sure if we don't have the discipline to keep this
expansion within bounds and avoid shortages or bottlenecks or demand pressures that fuel an inflation that is already too high.
One of the elements that is stimulative to the economy is fiscal
policy. It seems to me, as we are going into the fourth and fifth year
of expansion, it would make good sense-in fact, it hardly makes
sense to do otherwise-to start the deficit on a decline as we build up
our employment levels and as we get our economy working at a
higher level of its potential capacity. I think it would be well if we
could start turning the deficit down.
Senator SARBANES. Well, at what level does the GNP have to expand in order for unemployment simply to stay still and not increase?
Mr. MILLER. If we were expanding at 3¼ percent, I think one could
stabilize unemployment; but I think we now need to let the economy
grow at a faster rate to reduce unemployment.
Senator SARBANES. Let me get this straight. You think with a 3¼percent expansion of GNP that the unemployment rate would be
stabilized?
Mr. MILLER. If you can maintain GNP at a 3¼- of 31/2-percent real
growth rate, I think you will have a fairly stable state, based on our
past experience. That would change as the demographics of the labor
force change, but I think it would generally be true for the next few
years.
Senator SARBANES. So your working premise is that a 3½-percent
increase in GNP stabilizes the unemployment rate at whatever level
it then is?
Mr. MILLER. Other factors being equal. There could be an infusion
into the labor force, as I say, because of demographic changes, such
as those which we have had in recent years. But I think we are over
those now. If we are over the bulge-and I think we are-of entries
into the labor force, then we could have a stable unemployment rate.
Senator SARBANES. Well, your working premise is that we are over
any unique demographic problems and that given a 3½-percent increase in GNP that would give you unemployment rates stabilized
at their current level?
Mr. MILLER. Yes. That's correct.
Senator SARBANES. I'm i1;1terested in how with significant unemployment and significant unused resources you perceive the deficit as
being a prime contributor to inflation.
Mr. MILLER. Senator, by the time this new fiscal year comes into
being, it appears that we will be way up in the high eighties in percent
of capacity utilization. And I think that capacity utilization is understated because I believe much of our capacity in this country is obso-
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lete, is high cost; if we bring it into use we are going to foe] the fires
0£ inflation even further.
Senator SARBANES. So your next working premise is that the GNP
expansion that you foresee will bring us to unacceptable levels 0£
plant utilization ; is that correct ?
Mr. MILLER. It will begin to impinge upon shortages in certain
areas; not universally.
Senator SARBANES. H you were making fiscal policy, would you take
out 0£ the economy the spending stream that will be taken out by the
increase in the social security tax and the unemployment tax-all the
increases in payroll taxes which will occur at the beginning 0£
the next calendar year?
Mr. MILLER. I would prefer to see us find some way to fond social
security, with integrity, that would obviate the need for increased
payroll taxes because those are direct costs and feed inflation; that
may require some reforms in social security.
Senator SARBANES. Well, without getting into the specifics 0£ tax
policy, I'm interested here in terms 0£ making fiscal policy-would
you pull out 0£ the spending stream what those increases in taxes will
pull out at the beginning 0£ the next calendar year with respect to a
fiscal policy that would sustain continued growth in the economy?
Mr. MILLER. Senator, I didn't quite finish my philosophy in the
comment I made. You will recall that I was commenting on the deficit
that we are £acing in an aging expansion. I also happen to believe
that the best thing for us long term is to reduce the level 0£ government activity in the economy and to increase the level 0£ activity in
the private sector, which means tax cuts would be desirable. In order
to accomplish both-reduce government activity and reduce the
deficit-and in order to be sure the tax cuts would aid both individuals
and, hopefully, business capital formation, my suggestion was to defer
its effectiveness £or one quarter; this would mean that the tax cuts
would come into effect coincident with the increase in the payroll tax.
They would be an offse.tSenator SARBANES. All right. Now we're getting somewhere. I was
not clear in my own mind about your comments with respect to the
tax cut and other comments you have been making-you have been
making a lot 0£ them around town here recently.
Mr. MILLER. At least I have been quoted as making them.
Senator SARBANES. I hope you have not been quoted without making
them. There have been comments 0£ yours with respect to your wor~
ries about the increase in the payroll taxes. Now I take it that you
want to offset that increase and you are now saying that if the tax
cut took effect at the beginning of calendar 1979 rather than in October of 1978, that would remove your quarrel with the tax cut proposal.
Mr. MILLER. I have said before to this committee, as you will recall,
that I thought a $25 billion tax cut package was the most that ought
to be considered right now; I wasn't quarreling with the level. I am
now suggesting that it be put off for a quarter. As I understand the
tax package, the cuts were proposed to come into effect on October 1
and the increased revenues were to come into effect in .January. H the
whole package takes effect ,January 1, it would make an $8 or $9
billion contribution to reducing the deficit; and the tax cuts would
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come into effect, for individuals, coincident with the increase in
social security taxes.
Senator SARBANES. 1V-ell, I can see that strategy as part of a balanced development of the economy. I'm not certain that failure to
implement tax cuts would mean that the deficit will be less because
if it results in the economy not moving forward an increase in unemployment would occur and the end result of that is the deficit is going
to be larger rather than smaller. That's one of the difficulties in making fiscal and monetary policy is that you have to keep the economy
moving forward if you're going to actually impinge on the deficit.
Otherwise, you may take measures which will result in the deficit increasing, although the measures were supposedly designed to decrease
the deficit.
Mr. MILLER. Yes, I think that's correct. But my view is that the
economy will continue to grow; in fact, if we let it grow too fast we
will run into more inflationary problems which ultimately will cost
us more. Therefore, I think pushing back the effective date of the tax
cuts a little is a kind of moderation that might be very helpful.
Senator SARBANES. So your proposal in that area is simply to implement the tax cut at the beginning of the calendar year at the same
time that the increases in the payroll taxes were to take effect?
Mr. MILLER. Yes. There are two ways that the deficit can be reduced, and only two, that I know of: Spend less or collect more. I
was suggesting that we keep collecting for one more quarter in order
to facilitate the transition into a more sustainable growth rate. We
have been growing at a very rapid rate from a very slow start, so
it's important that we phase things in. Now we've also got to recognize that the unemployment problem is becoming more and more
structural, and that the way to solve structural unemployment is to
target programs at it.
Senator SARBANES. Do you think we are at a point where the unemployment rate right now, the structural aspects of it, are the predominant aspects?
Mr. MILLER. I think they are far more important than the cyclical
aspects right now.
Senator SARBANER. At 6.2 rate of unemployment?
Mr. MILLER. 6.2 is too high. As you know, I am expecting us to get
down under 6 in this period.
Senator SARBANES. You say 5¾ to 6, which is not much of a drop.
At that level, is it your working premise that the structural components of the unemployment rate are the primary or the dominant ones
at that level of unemployment?
Mr. MILLER. Yes, because of demographics. 1V-e have had a great
influx-which was good for the economy-of women into the labor
force. I think that's ended and the bulge is being absorbed. The problem more and more is unemployment of minorities and young people;
I think that's highly structural and we have to attack it very hard.
I will not be satisfied with the levels of unemployment projected
here. My forecast is actually rather optimistic, I think, compared to
most forecasts I have seen, because I believe that what we have seen
in the first quarter-the addition of jobs in the manufacturing sector
and in many other production sectors-is very encouraging. It looks
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like business has a demand for more labor which is now being put on
the payroll. So my view has been very encouraging in that regard.
Senator SARBANES. If your policy of either reducing spending or
increasing collections in order to reduce the deficit were to lead to a
downturn in the economy, if that were to be its result, what would
then be the consequence with respect to the deficit? Wouldn't it be an
even larger deficit than would otherwise happen? I know that's not
your working premise, but that's the judgment that has to be made,
is it not?
Mr. MILLER. The tough judgment we have to make is that if we
allow inflation to go ahead and run its course, and if we feed it in
any way, we are going to create conditions for disinvestment and we
are going to have a recession sooner or later-and it's going to be
severe; and it's going to entail a very big deficit and very high unemployment. If we can lean against inflation, and take some other disciplinary actions and keep ourselves growing at a steady rate, we can
avoid a recession; and, I believe, over time we can actually have more
people employed for more months and make a greater contribution
to the stability and growth of the Nation than if we risk inflation. If
we risk inflation, we are headed for trouble for sure; if we lean against
it-Senator SARBANES. Of course, there's a peaches and cream solution
which it is obvious we all seek which is to try to drive down unemployment and bring inflation under control. Now what I'm concerned
about is the assumption, first of all, that a deficit at high levels of
unemployment and high levels of unutilized resources-and I know
you quarrel with the latter on utilization-that such a deficit is fueling inflation in a significant way. It seems to me that the inflation we
have is attributable to a number of other factors as well to which
we also have to address ourselves.
Mr. MrLLER. Senator, to go back to what I said a moment ago, if
we took the action I'm suggesting to create conditions for substantially increased business investment such as a very liberalized depreciation-Senator SARBANES. Which would increase the deficit.
Mr. MILLER. No, it would not; because this would provide more jobs,
would create activity that would work through the economy to produce profits and sales. A tax cut creates more consumption demand:
We pull up demand and use obsolete facilities at too high a rate and
push inflation up. If we work on the supply side, and put our jobs into
building plants and equipment, we both put people to work and start
reducing the unit cost of producing goods.
Senator SARBANES. I don't quarrel with that.
Mr. MILLER. That's what we ought to do.
Senator SARBANES. If you were a businessman, why would you develop more plant and equipment if you didn't feel there was going
to be the demand for the product of that plant and equipment at the
end of the process?
Mr. MILLER. I'll tell you one reason I would under the conditions
of inflation: To reduce costs. When I was a businessman, I went out
to get the costs--
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Senator SARBANES. You're making assumptions about the existence
of demand for the product?
Mr. MILLER. Oh, yes. And I can guarantee you that if we sent out
a signal loud and clear to American industry that we were going to
reduce the Federal deficit and that we were going to fight inflation,
we would be sending a signal for the stock market to go up; the
signal for business investment to increase; the signal that you could
count on markets and you could produce goods and you could invest
and bring down costs. And that's what we would see.
Senator SARBANES. Now you could send out all those signals and
if you didn't have demand at the end of the process for the product
of business why would they bother to respond to them? I don't minimize the importance of all of those signals, but it seems to me it has
to be done in the context of the presence of demand for the product
of the companies.
Mr. MILLER. Long-term demand in the United States is sufficient to
continue our growth. I don't think there's any lack of underlying
demand. We are underproducing in housing, and we really are shortfalling in many sectors. I'm not concerned about demand. I am concerned about supply, because if we continue to stimulate the demand
side and we don't provide for the supply side, we will be doing what
we have been doing for so many years: Building ourselves into a consumption society, a throwaway society that never replaces its capital·
base. Any society you have ever seen that consumes like that consumes
itself into oblivion; it's a very untenable position. We've got to look
for savings, investment, and productivity as a means to improve the
standard of living and the employment opportunities and to enrich
the lives of the American people.
Senator SARBANES. Well, no one quarrels with that.
Mr. MILLER. And it will be done if business people see more chance
for a climate of stability-Senator SARBANES. Nobody quarrels with savings, investment, and
productivity. The problem is insuring that people are working and
resources are used. If they are not working we are going to have a
tremendous-Mr. MILLER. If we let inflation get out of hand we are going to
have a lot of people not working and enormous deficits. That's the
problem.
Senator SARBANES. Well, I'll come back to it in my next round. I
see the red light is on.
The CHAIRMAN. It's been on for 15 minutes.
Senator SARBANES. I've imposed excessively on the chairman's time.
The CHAIRMAN. Let me follow up just a little bit on what Senator
Sarbanes was asking about.
In the first place, as far as the capacity utilization figures are concerned, they are the Federal Reserve figures. So if they're wrong, as
you implied that perhaps they are, you ought to change them. You
ought to correct them. That's your responsibility; isn't that correct,
Mr. Chairman?
Mr. MILLER. Senator, there's a difference between capacity utilization and the cost of using that capacity; my point was not to quarrel
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with whether we have the capacity, but to point out that much of the
capacity is high cost capacity that's benched when the economy goes
into a recession. Business first shuts down it least productive-The CHAIRMAN. I understand that, but as I understand the Horton
series is supposed to take that into account. They don't show that we
are near 100 percent capacity. We are well under that. They also don't
show much of an increase in capacity utilization in the past year despite the fact we had almost a 5-percent real growth. There was no
increase in utilization of capacity between March of 1977 and February of 1978 which is the last month for which we have figures on the
Federal Reserve manufacturing series, the materials series, the commerce series, or Horton series. They all show a fairly stable utilization figure and at a point where there shouldn't be pressure on
resources that would be inflationary.
Mr. MILLER. Senator, you're looking at February which we know
is a down month in which we had negative growth because of the
weather.
The CHAIRMAN. Take 1977 or January of 1978. The February figures aren't very different. They are very close to it.
Mr. MILLER. Senator, I suppose we all have our different judgments
about these figures. My judgment is there's a difference between correcting these series for obsolescence and recognizing that the last 10
percent of capacity of many basic industries in the United States are
high cost capacities.
The CHAIRMAN. We have the figures here and they don't show any
industries where they are close to the top. There are one or two that
are 85 percent, but durable goods is 79 percent, basic metals is 75
percent, nondurable goods is 85, textile is 85. If these statistics
are unsatisfactory, it would seem that the Federal Reserve should
recommend some kind of a series that would tell us. Give us a signal
as to when industry is moving into a high cost facility so we have
some notion that we are pressing against our capacity availability
and that there is an inflationary effect. Wouldn't you agree that would
·
be useful~
Mr. MILLER. Senator, I agree it would be useful, but I don't think
I've made my point. Those indexes have to do with capacity. You have
capacity; I'm not quarreling with the figures. I'm saying that when
you put that capacity in the stream of operations your unit costs go
up, and that there's a difference between a series that has to do-The CHAIRMAN. In general, however, it was Dr. Burns' position, and
it's been the position of most of the witnesses who have appeared here,
that they don't go up until you get over 90 percent of the Federal
Reserve figure. Now perhaps you quarrel with that and you make it
88, but it's certainly well above what it is now.
Mr. MILLER. Senator, there's been an interesting phenomenon in
the last two recessions in the United States, and that is that business
investment has lagged longer and longer in the recovery cycle and
therefore has come into being too late to offset inflationary pressures.
My argument is still that we are late in this cycle for business investment, that we are going to run into cost pressures in using the capacity
we have and that we need to change our emphasis and start creating
a climate for larger and earlier fixed investment that is mostly related
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to modernization cost reduction. So I think I agree with you, yes; if
we had a series that would tell us at what percentage of use a steel
company's capacity would add $10 a ton we'd know more; we don't
have that. My experience is that when they put their last unit on line
it costs them a lot more than if they have been operating without it.
The CHAIRMAN. Now you mentioned that all parties-Congress, the
executive branch, and the Fed-have to show restraint, and I agree.
Are you concerned about the $60 billion budget deficit proposed for
fiscal year 1979 ?
Mr. MILLER. Yes, sir.
The CHAIRMAN. Now if the Congress were to reduce that deficit
either by cutting spending or by not reducing taxes as much as has
been proposed, or by a combination of the two, do you believe that
the Fed could modify its monetary policy?
Mr. MILLER. I think it would take a great deal of pressure off of us.
I think I would be very excited.
The CHAIRMAN. How much could short-term interest rates be reduced by the Fed if Congress cut the budget deficit by $25 billion one
way or the other?
Mr. MILLER. I'm afraid, Senator, I would have to wait and see when
and how it took place, but we would see the possibility of significantly
lower interest rates.
The CHAIRMAN. Now this appeals to me very much. I read in the
Wall Street Journal a day or two ago that corporations were now
beginning to feel the pinch of higher interest rates, cutting back their
borrowing, cutting back their plans for expansion, and this seems
to me to be so counterproductive. It's exactly the wrong direction.
Here we're having Government increasing this year about 10 or 11
percent if you compare the projected 1979 to 1978 spending, and you
have the private sector cutting back. It's because your monetary policies are at least the direct villain, although I know there are reasons
why, as you have explained, that you felt you had to do this.
. Mr. MILLER. I think you're correct. I notice that many firms are now
borrowing from banks; they don't want to go into long-term markets
because of the high interest rates which are inflation-induced. If we
can get that inflation down, if we can get the deficit down, I think we
will see lower interest rates.
The CHAIRMAN. Now would you favor an amendment to the
Humphrey-Hawkins bill to establish a specific numerical goal for the
rate of price increases by 1983 ?
Mr. MILLER. Senator, I saw your proposal on that and I want to
commend you_ for it. I'm not sure that specific numbers in that billwell, let me back off a moment. I think specific targets are a good
idea. The thing I was concerned about was that we must be sure we
don't set specific numbers over too long a period, because times change
and I think we have to leave some flexibility for Congress to review
its targets in the light of future realities. But your proposal is to get
down to 3 percent by a certain date and then move on to zero, and
I think that's the right direction. Whether the timing or the numbers are just right or whether you want to leave more flexibility for
a future Congress, I don't know; but I think your philosophy is
absolutely correct.
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The CHAIRMAN. Now the argument on the other side-of course I
wholeheartedly agree with that and I'm very grateful for your response. The argument on the other side is that the Congress has:this is what I get from the Secretary of Labor and others who disagree with our position-is that we have considerable control over
unemployment, not complete but almost. We can reduce unemployment if we have the will is the way they put it. But they say we don't
have that kind of control over inflation. We might set a goal but
there are so many elements that we can't control that it's more of a
wish than something that we can achieve.
Mr. MILLER. I think we can achieve all of those goals, but we won't
achieve them unless we set ourselves out to do so. I£ we do set ourselves out to do so, we can accomplish those goals. It does take some
disciplining that we haven't been used to £or a while, but I think we
need that.
The CHAIRMAN. Let's see if I can reconcile the statements that we
got yesterday from Dr. Eckstein and Dr. Santow and yourself on
GNP and increasing the money supply. Your estimate £or the next
year of real GNP growth, 4½ to 5 percent, was different from those
given by Dr. Eckstein. He had a 4 percent real GNP growth. Dr.
Santow was different from yours also. He had about a ~½ percent
real GNP. Now Dr. Eckstein forecasted 6½ percent M 1 growth as
consistent with a 4 percent GNP growth and Dr. Santow had a 6 percent M1 growth which he felt was consistent with 3½. Now those two
figures were fairly close. What's your money supply expectation?
Mr. MILLER. Senator, were they talking about first quarter to first
quarter?
The CHAIRMAN. That's right.
Mr. MILLER. That's quite a large discrepancy. And with the second
quarter performance that's a very discouraging outlook, because if
you have 7 percent GNP growth in the first quarter-and if Dr.
Eckstein "3/as talking about 4 percent over those £our quarters-then
he's got very low growth rates £or the other quarters. I think the
economy is stronger than that. I just have to disagree. I believe we
are going to have a very big upsurge in the second quarter.
The C}l:AIRMAN. He thought we'd have a bigger one than you
tb,,ight ir,. the second quarter. He recognized we have a negative first
q:rnrter, number one. Number two, we have about an eighth and a
fraction in the second quarter, and then ahout a 4 percent in the last
two.
Mr. MILLER. 4 percent in the last two? 4 percent over four quarters
then?
The CHAIRMAN. Well, that would figure over £our quarters-8 and
4 and 4 add up to 16, divided by 4 is 4.
Mr. MILLER. But you lost a quarter there.
The CHAIRMAN. The first quarter was negative.
Mr. MILLER. I see.
The CHAIRMAN. We're starting for the whole year.
Mr. MILLER. My figures were second quarter, third quarter, fourth
quarter and first quarter 1979. Therein lies the difference, I think, for
M1, I believe we can arcommodate the growth in GNP that I have
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projected, which I think is an encouraging growth rate, with the
money supply within the ranges of 4 and 6½ percent for M1 and 6½
to 9 percent f?r ~ 2 , as I have _i1_1dicated. I believe that there are ~11
kinds of contmumg opportumties for th<?se w~o hold cash or. its
equivalent to use it more efficiently. ~eloc1ty. will have to be f!1-1rly
good to do tha.t, but I believe that's likely with the new techmques
that are developing for the managemnet of cash resources.
The CHAIRMAN. It would seem as if we would have to be close to
the upper end. Incidentally, Dr. Eckstein had a fascinating analysis.
He said he uses something like 100 different variables that they crank
into their computer and they figure that the odds that you would stay
within your range were about 73 percent, 27 percent you wouldn't,
zero that you would go as low as 4 percent, which brings me to a
question I° want to bring up a little later. My time is up, but it would
seem that your ranges are too wide a~d that your lower range-it
may be for psychological purposes, but 1t doesn't serve any real prospect because he indicated there wa.'! just a zero possibility you were
going to get 4 percent growth in the M1.
Mr. Mn,LER. WeH, I appreciate having those odds. Anybody who
will give me a 7:3 percent change of getting in the range at all is
giving me a pretty good mark because, as I say, we haven't been
within the range for a while.
The CHAIRMAN. You can get within some ranges. Look at what you
did within the Federal funds. You were within the ranges every time.
Mr. MILLER. That's kind of easy. Pick a hard one.
The CHAIRMAN. As you say, it depends on whether or not we have
the will.
Senator Sarbanes?
Senator SARBANES. Chairman Miller, I wasn't sure from one ·of
your answers to the chairman what your position is with respect to
the projected Federal budget for the next fiscal year-the projection
of both the Senate and the House is below that of the administration
as you are aware.
Mr. MILLER. Yes.
Senator SARBANES. Now is it your view that the deficit should be
even lower, other than the lowering that might come about by delaying the tax cut until the beginning of calendar 1979-other than that
reduct~on, which might result in the deficit if you make certain as!'lu~~tions about how the economy would continue to move-is it your
pos1t10n that the deficit should be significantly lower than that? I
thought I heard a figure of $25 billion less and you sort of assented to
that figure.
Mr. MILLER. No, sir. I was saying that I :felt that if we could get
the deficit in fiscal 1979 at or below the deficit in fiscal 1978 that the
would be a substantial an~ en~ouraging improvement. My s~ggestion
to delay the tax cuts, which, 1:f I'm correct, would reduce the deficit
hy $8 billion or so in the quarter, would bring us down to about the
deficit projected :for the current fiscal year.
Now, Se_n~t?r, I would say that I'm not trying to get into the area
~f respons1b~hty of t)i.e Congress or the administration. My analysis
ts that that 1s a consistent way to reduce the deficit because it could
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hold the tax program together; you wouldn't have to tear it apart to
do that. There are other ways, of course, to achieve the lower budget
deficit. It would not be harmful to look at reducing spending. H you
could reduce spending more, then you could make more of a tax cut.
So I think there would be a lot of advantage to-Senator SARBANES. Wait a second. That's a difference in approach
but that's not a difference in deficit size, is it?
Mr. MILLER. No. I'm saying I would be satisfied personally with
a deficit of $53 billion in 1979 fiscal year.
Senator SARBANES. So your difference with what's been proposed
is the quarter's difference in the implementation of the tax cut; is
that correct?
Mr. MILLER. Yes, sir.
Senator SARBANES. Now the notion that you should reduce spending and pick it up with a tax cut, that's a difference in approach as
to how a deficit can best serve you, but it's not a difference in the
size of the deficit, is it?
Mr. MILLER. That's correct. The only thing I am saying is that the
Congress might want to look at whether they get more bang for
their buck by less Government spending.
Senator SARBANES. I understand that, just as you differ with the
composition of the tax cut as I understand it.
Mr. MILLER. That's right.
Senator SARBANES. H you were putting together the details of the
tax cut you would have a somewhat different program than what
the administration has proposed as I understand your testimony.
Now I'm interested in this point of yours, because it has some
philosophical implications, about the question of demand and supply
and the encouragement of demand and the failure to encourage supply. It seems to me with high unemployment the clearest thmg we
are doing is encouraging demand and failing to encourage supply
because if you're going to have income maintenance programs for
millions of people who aren't working, then you create demand on
their part and they are not producing and therefore not making
any contribution on the supply side of the economy-isn't that
correct?
Mr. MILLER. Yes. Every income maintenance program that I have
seen starts out with the idea that we will maintain people until they
can get employment in the private sector. I'm saying the way to get
them permanent employment in the private sector is to stimulate
capital investment. Otherwise, you just don't give them a way out;
you create tremendous frustration and social problems that are
enormous. That's why it's important to build the capital stock up
and create a larger industrial base that, in turn, creates a more
permanent employment opportunity for larger numbers of people;
their demands then will become even more appropriate to sustaining
even further economic growth. So it's just that if we give people
spending power, but never create the underlying base of production,
ultimately we run into serious problems. I see the humanistic reasons
and I agree with the humanistic reasons for sheltering people from
distress, but I want to lead them into something more permanent and
more self-satisfying.
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Senator SARBANES. But the fact is they are sheltered and the emphasis should be to put them to work; otherwise they aren't producing and you're adding to demand and not contributing to supply?
Mr. MILLER. That's right.
Senator SARBANES. What kind of monetary policy do you envision
the Fed pursuing if fiscal policy proceeds along the lines that you
have been suggesting, which is essentially as it is now proceeding
with the exception of implementing a tax cut at the beginning of
the calendar year rather than on October 1?
Mr. MILLER. Senator, the thing that has concerned me most in
my role at the Federal Reserve is the prospect that the forces of
inflation ·will continue to build, aud that counter-action will be left
too much to monetary policy, which would leave us at the Federal
Reserve with a very difficult dilemma. We ·would have the choice, on
the one hand, of acting against that build-up of inflation, which surely
·would result in interest rates being higher-inflation breeds higher
interest rates; long-term interest rates really aren't influenced directly by the Federal Reserve. And higher interest rates would
result in a slowdown of the economy and in not being able to sustain
its grow.th or create the employment that you and I both want. That's
an unhappy alternative. The other choice would be to go ahead and
print money and finance inflation, in which case inflation would
grow at a higher rate and when it got into double digits ·we'd have
such di~intermediation and such a dry-up of investment that would
have to-Senator SARBANES. I don't want to be drawn into those extremes.
My question to you was if the fiscal policy pursued by the Federal
Government in fiscal 1979 essentially followed your view, which I
take it is pretty much what is now proposed to be done with the
exception of delaying the tax cut for a quarter, its effectiveness-its
effective date-what monetary policy would the Fed anticipate pursuing under those circumstances?
Mr. MILLER. Under those circumstances, we would expect the
dilemma would be less difficult; we would find that there would be
a reduction in the inflationary forces and we would not be pressed
as hard and we would therefore be able to have a less restrictive
monetary policy.
Senator SARBANES. Less restrictive?
Mr. MILLER. Significantly so.
Senator SARBANES. Significantly less restrictive than what you are
now starting to pursue?
Mr. MILLER. All I can say is that I would hope that would be
possible. How less restrictive depends on the change in the fiscal
situation on the timing of tax cuts, on international events, and so on.
But my point in telling- you of our dilemma is that the choices are
not happy ones. That's why we would welcome a more concerted
action by all sectors of the economy, because that would allow us a
less restrictive monetary policy and it would, perhaps, allow us to
see interest rates trend down again. And if that happens, then I
think we would all be happier.
Senator SARBANES. Well, I think that's a good point. I don't know
that anybody would really quarrel with the last point made in your
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statement today which was you shouldn't be left to do it all alone
with respect to inflation and, in my view, with respect to the unemployment question. Those are the two things we have to address
ourselves to, hopefully in a balanced way.
Let me ask you this question. Do you regard the wage increases in.
recent years as leading the inflation or following the inflation?
Mr. MILLER. Initially they followed the inflation, but they have
led to indexes as a protection against inflation. And what happens
when you have an indexed system, of course, is that you have a kind
of a treadmill: There's no penalty for inflation under an indexed
system, and if there's no penalty there's a tendency not to be as active
in curbing inflation as I would like us to be.
Senator SARBANES. What do you think about the Okun view that
you should use taxing policy to ease the impact of inflation on wages
if in turn you hope to get some restraint in the wage settlements and
that this is a constructive mode of thinking in trying to lower the
settlements and the expectation rate. That's a way to trade off and to
induce some restraint into the settlements and gear the whole thing
down. Is there any benefit to be picked up by that approach?
Mr. MILLER. I think we are building in structural inflation when
about 50 percent of the income recipients in the United States are
indexed. If there's no penalty for inflation there's no fight against
it. Therefore, any system that has an inflationary counterstructure
is worth examining. There are some problems with the so-called
TIP program, the tax-based incomes policy: We don't know how
well it would work. There are possibilities that it would behave in a
way that we don't anticipate. I welcome the studies that are going
on to examine this approach. I welcome the data that's being gathered to try to analyze it, and I certainly think the general approachthat is, of finding some self-disciplining way of making the system
work against the bias of inflation-is very helpful. But I would
not, at this point, suggest we adopt it because I don't know that much
about it. I would encourage these studies and hope they go forward.
There are two approaches, as you know: One is the carrot and one
is the stick. You've got to be careful with the penalty approach because there may be some cases, outside the guidelines, where it doesn't
apply, or you might get negative growth in industries that are important. If you try the carrot approach, you've got to be careful
that it doesn't in any way get abused and become a monster because
we haven't understood it. But I'm very much in favor of exploring
these areas.
The CHAIRMAN. I hesitate to enter into what may be a SarbanesMiller agreement-I don't know-but it would seem to me a postponement of the tax cut from October 1 to January 1, which I understand would reduce the deficit by maybe $9 billion, would be so
slight, particularly in an economy of this kind where you have 6.2
percent unemployment maybe going down to 6.6 or 5.8, and in a
$2-trillion economy, that I think it could be that postponement might
have some psychological effect but it would be rather slight.
Senator SARBANES. Mr. Chairman, I vrnnt to-The CHAIRMAN. Let me just say one more thing, Paul. There's one
element involved here that I think there's a great difference-maybe
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no difference in the deficit, but a great difference as far as the American citizen is concerned as to whether you have a tax cut or don't
have a tax cut, and instead have a spending cut. The taxes are a big
element in the cost of living. They are one thing you cannot avoid.
You can eat less. You can maybe spend less on housing, but you have
to pay those taxes whether you like it or not. They are there and
they are real. So that if you cut spending, Government spending,
you do have an overall inflationary effect that is beneficent to the
consumer, but if you simply postpone the tax reduction or raise taxes,
I've found that most consumers say, "Thanks, but no thanks."
Senator SARBANES. Let me simply say I want to disavow any
agreement here. I was simply seeking to clarify-Mr. MILLER. Chairman Ullman is going to be very upset.
S_e~ator SARBANES. I was simply seeking to clarify the Chairman's
posit10n.
Mr. MILLER. I will make a simple point. If you all want to negotiate, I welcome that you do, because if you can get the deficit down
by less Government spending so that larger tax cuts could be passed
out I would be very happy about that.
The CHAIRMAN. You really think the postponement of the tax cut
from October 1 to January 1 would significantly affect inflation to
an extent that you can follow a different monetary policy?
Mr. MILLER. Inflation is a combination of realities and expectations. I think a postponement would dampen expectations arid
therefore ,vould be very, very helpful.
The CHAIRMAN. Is it true that what the people with the expectations are looking for is not a postponement of the tax reduction;
they are looking for a spending reduction?
Mr. MILLER. They would like to see a spending reduction. Having
been in "Washington for 6 weeks now, I have begun to wonder
whether Congress is going to cut spending, so I thought maybe the
other way-The CHAIRMAN. But I can't imagine people throwing their hats
in the air and saying, "Hurrah, we don't get a tax cut."
Mr. MILLER. I have had an enormous amount of mail from people
saying that would be great. They would be willing to forego a tax
cut if you could cut inflation.
The CHAIRMAN. I find when they vote they don't feel that way.
Mr. MILLER. Well, of course, I don't have to run for office again;
we've already been through that.
The CHAIRMAN. Well, 4 years come around pretty fast.
Mr. MILLER. So do 6 years.
The CHAIRMAN. When the Open Market Committee meets each
quarter to decide on its monetary aggregate range, for example, for
the year ahead, they must have a pretty set agenda and approach to
policy formulation. Could you describe that approach to us? Do~s
the staff present its economic forecast and a review of the economic
conditions first? Do they forecast a growth ·in the monetary aggregates given current conditions? Does the staff then desc~ibe t~e
different possibilities confronting the Open Market Committee m
terms of monetary aggregate ranges and the economic factors that
would result?
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Mr. MILLER. Yes, sir. That's more or less what's done.
The CHAIRMAN. Now if you do that, if the Open Market Committee needs to have such extensive projections before it makes the
decisions with respect to monetary aggregates to understand the full
implications of these alternatives, how do you suppose the members
of this committee or other members of Congress can make any sense
of your policy when they are viewed only in terms of the monetary
growth rate ranges? You see we are not given the other material and
it seems to me we ought to have it. Don't we need the same type of
information, the same forecast, that the FMOC members receive in
order to understand your policies?
Mr. MILLER. Senator, I think that would create a very serious
problem £or us. I'd like to accommodate your point in another way,
i£ I could. My personal thinking is that the staff work presented to
the FOMC is background. The individual members of the FOMC
have access to additional economic information. There are Reserve
bank presidents who have information from their own economists
and from the businesses and banks in their areas ; and, strangely
enough in this world of economics, there's not always unanimity of
opinion. The Governors and I have other inputs from our experiences and our own personal contacts in general. Moreover, we want
the staff to be unfettered by any tendency to speak for another audience. We want to hear the cold facts from them and then we want
to massage those £acts. And when we are through massaging them
I would be very pleased-and I hope this presentation has been a
step in the right direction-to inform you in writing of the economic
outlook that I believe to be consistent with the ranges that have
been established and that can be accommodated.
The CHAIRMAN. Will you give us that in quantitative terms?
Mr. MILLER. Yes, sir. It's right here.
The CHAIRMAN. When I wrote and asked you, I got the impression that you wouldn't provide that to us.
Mr. MILLER. It's right in my testimony, information in quantitative terms on the outlook of the economy and growth.
The CHAIRMAN. I understand that's your own. What I wanted was
the Federal Reserve estimates. Dr. Burns used to give us his own,
too, but what we would like is the Federal Reserve's.
Mr. MILLER. The FOMC is the group that sets the ranges and it
has 12 members. I know how hard it is to get every member of this
committee to agree on anything; it's also very hard to vote on an
economic plan. What I can tell you is that I don't think there are
many who straggle outside 0£ the figures I have given you., I h~ve
listened to all of the FOMC members and, Senator, I don t thmk
you're going to find that what I'm giving you represents any modification from the mainline of thinking of the FOMC.
The CHAIRMAN. ·wen, that's helpful. Let me ask you abo~t what
may be a straggler. On pages 14 and 15 of tl~e M~rch _21 pohcy record, one member of the Open Market Committee is said to have remarked "That the unemployment rate had come close to the zone
that he ~·ould characterize as reflecting full employment."
The record goes on to say that this suggests that output growth
should be brought down soon toward a substainable longer term
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rate. It appears that your tighter monetary policy stance as indicated by the 7-percent Federal funds rate would be consistent with
this point of view.
Would you characterize that opinion about the unemployment
rate and the need to reduce growth to a sustainable longer term
rate as one that is widely held by the members of the FOMC at this
time? Is that opinion consistent with your own view of the economy?
Mr. MILLER. As to the position that we have near full employment, I'd say that is not by any means the opinion of the FOMC.
I think everybody on the FOMC would like to have a long-term
sustainable rate of growth. We all have differences of opinion, but
I would say that's an opinion that is outside of the consensus. We
reported it because we w!int the record to show that opinions are
widely varied.
The CHAIRMAN. In going through your statement I found it very
strange that no reference at all is made to the Federal funds rate or
any other interest rate. It was also strange to see only one short
paragraph on credit market conditions. The Federal Reserve has
got to give more consideration to financial and credit conditions
than this. It seems to me if there's any agency in Government that
has responsibility with respect to interest rates it's yours.
Why didn't your testimony discuss past interest rate development
and credit markets in detail? Don't those have impact on the economic developments?
Mr. MILLER. Perhaps I should have expanded on the discussion of
interest rate changes in the last year. I tried to note short-term and
long-term changes. Maybe I should have expanded that discussion;
I would be happy to on another occasion.
The outlook for interest rates in the future, I hope, is that inflation can be curbed and that interest rates can moderate. Absent
that, I think we all are realists and know that if inflation continues
to grow, interest rates, regardless of what we do, will be higher.
The CHAIRMAN. So you feel that interest rates are entirely exclusively a function of the inflation expectations; is that right?
Mr. MILLER. Over time, Senator, long-term interest rates have
been tied very closely to inflation. All the studies I have seen show
that over time the real cost of money is pretty stable and that the
difference between the real cost of long-term capital and its cost in
nominal dollars is inflation.
The CHAIRMAN. Well, it would be helpful if we could get a more
precise notion. You say over time. That may well be.
Mr. MILLER. Month to month it may vary, of course.
The CHAIRMAN. But we would like it by quarter and certainly by
the next year or two a notion of what you think would happen to
interest rates.
Mr. MILLER. I will certainly see if I can be more helpful to you
next time around in that regard. I apologize for not fleshing it out
now.
The CHAIRMAN. In view of the conclusions that you have come to
regarding inflation, what is your expectation with respect to interest
rates for the next year, 1979?
28-083 0 - 78 - 12
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Mr. MILLER. I think interest: rates are going to be under upward
pressure because of the inflation level. The 63/4 to 7¼ percent inflation that I have indicated ai'i my expectation means that there will
be pressure for higher interest rates on long-term capital.
The CHAIRMAN. Does that mean the Federal funds rate is likely
to move above 7 percent?
1
Mr. MILLER. It may or may not. ; Of course, that's a short-term
rate and it depends on what's happening on these other fronts. I
can't really predict. We are going to have to use the controls we do
have on the Federal funds rate in trying to make sure that the monetary aggregates do not take off in a direction that feeds inflation. I
cannot predict to you whether that will mean a higher Federal funds
rate or not.
The CHAIRMAN. We were warned by Dr. Eckstein in his view
you're close to-you're not at yet, but when you get to 7¼ percent,
you're close to a point where you're going to have severe disintermediation where you're going to have money that's going to be leaving
savings and loans and therefore coming out of the housing market
and, of course, in my view, that could very easily precipitate a
housing-led recession. It often has in the past when the interest rates
have gone up. That's the most sensitive area of the economy to
changes in interest rates.
Mr. MILLER. We are concerned about that. I would point out to you
that the thrift institutions are in a little better condition than they
were previously because they have more long-term deposits. You
probably noticed the other day that the Federal Home Loan Bank
Board reduced its liquidity requirements for member Federal savings and loans, which released some more resources for housing. So
there are counter moves that can be made in case inflation seems to
create a problem in the housing sector.
The CHAIRMAN. If you will look at the second chart here you will
notice that the growth of deposits in savings and loan institutions on
the bottom, it's very clear, has gone down very steadily from August
of 1977 to date, every month below the month before. So you have
had that element. Now you're dead right. The funds aren't coming
out of it as much because of the long-range certificates, but you do
have that steady erosion there.
Mr. MILLER. Senator, of course we had a very high level of flows
to thrifts for quite a while, ,vhich is encouraging. "\V'e are concerned
about this slowdown in the rate of flows and, as you've probably
heard me say, it may be that attention will have to be given to lifting the ceilings on regulation Q to attract more funds. I don't think
the problem is a lack of credit. What is the problem is the rate competition: "\Vhen savers can go into market instruments instead of
into thrifts that's where you get a runoff. If the thrifts can raise
their regulation Q ceilings, they could attract those funds back.
The CHAIRMAN. Well, I want to get into that in just a minute.
Before I do, I'm not sure that we left with sufficient precision the
conditions under which you would feel the Federal funds rate might
have to go above 7 percent. Tell us a li.ttle more precisely what conditions might persuade you to have to take that course.
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Mr. MILLER. I think that if the money supply grows too rapidly,
if the economy begins to heat up and inflationary forces persist, we
are going to have to be very alert to leaning against those.
The CHAIRMAN. What do you have in mind as to the too rapid
growth in the money supply?
Mr. MILLER. I would like to see our money supply, as I have said
before, stay within the range that we have outlined for the coming
quarters.
The CHAIRMAN. Well, if it goes above the top range, does that
mean you might have to go to 7¼ percent or more?
Mr. MILLER. If it goes above our top range for any significant
period, and we don't think it's going to go back down, I think we
are going to have to do some tightening to get it back in control.
But I must reemphasize that it's a mistake to look at the money
supply weekly and monthly and that we, too, try to make a judgment of whether these weekly trends are ones that we have to lean
against or whether they are going to be self-adjusting.
The CHAIRMAN. What else are you looking at besides money
supply figures?
Mr. MILLER. We look at the performance of the economy. If the
economy were slowing down, I think we would have a different view
of the situation. We have to be pragmatic. I really think it would
be a shame to get wedded to mechanistic solutions. But if the economy is growing, if inflation is booming, and the money supply is
growing too rapidly, we would be doing the country a favor to get
the money supply under control.
The CHAIRMAN. What kind of a growth rate did you have in mind
as being excessive?
Mr. MILLER. If the economy performs the way we are talking about,
any sustained growth above our 6½ percent upper range would
concern me.
The CHAIRMAN. A sustained rate of 6½ percent in real terms?
Mr. MILLER. Yes, sir.
The CHAIRMAN. In your statement you said that if interest rates
increase further deposits subject to regulatory rate ceilings will be
placed at a substantial competitive disadvantage and unless there
are upward adjustments in regulation Q ceiling rates M2 and Ma
could fall short of the ranges set by the Federal Open Market
Committee.
The charts we have here indicate this process is well underway
because of the interest rate increase we already had since last April.
Furthermore, historically, once regulation Q ceilings have been raised
they have a habit of not being reduced. In fact, I think in the 35
years since we have had something like this they have never been
cut back. They have always gone up and stayed there. So this would
mean that an increase in these ceilings which pretty much deter- mines the cost of funds for thrifts would rise permanently and,
therefore, so would mortgage rates.
Wouldn't that be the result? And would that be a prudent move
at this time, given the effect higher mortgage rates would have on
inflation?
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Mr. MILLER. Senator, I share your concern. It seems to me that
one possibility would be to have an increase in regulation Q ceilings
that would be limited in time to, say, deposit flows over the next ~
months or 6 months or 9 months; that way you would be sure you
don't get a permanent rise.
The CHAIRMAN. I've thought of that. That's an interesting alternative. I just wonder if there would be the discipline to bring it
down if it ever got up. Won't you be likely to have to maintain that
if you're going to maintain the competitiveness?
Mr. MILLER. The regulatory agencies are anxious not to see the
ceiling raised up, so if they did move it up for a temporary period
I don't think they would feel pressure to keep it up. But the discipline would be that the increase would be put into effect only for a
certain time, and the ceiling would automatically go down, and it
would take additional action not to have it lowered.
If I'm correct, and if we all get together and fight inflation in
unison, then we won't need higher interest rates. We ,vould see an
opportunity for lower rates.
The CHAIRMAN. I hope that would happen but, as I say, it's never
happened in the past. We have a long, bleak history of it.
Mr. MILLER. That's our history on regulation Q. But we have
gotten inflation down in the past and I think we can do that again.
The CHAIRMAN. We haven't got regulation Q down.
Mr. MILLER. No; this is why I'm concerned about a permanent
increase. I think we ought to look at a temporary increase because
it might allow us the running room to see whether we can fight the
inflation battle.
The CHAIRMAN. Now you gave us a very clear and helpful statement about the Open Market Committee. It has adopted a target
range for bank credit for next year of 7½ to 10 percent.
Mr. MILLER. Yes, sir.
The CHAIRMAN. But I'm not sure I understood the term "bank
credit." How do you define that?
Mr. MILLER. Bank credit is made up of all the holdings of investments and loans of banks, both private and Government.
The CHAIRMAN. Can you tell us how that relates to the total of
funds raised by the various nonfinancial users of credit?
Mr. MILLER. The nonfinancial?
The CHAIRMAN. N onfinancial users of credit.
Mr. MILLER. It includes all banks-not just Federal Reserve
members-so it really represents the total amount of credit being
extended by banks to all financial and nonfinancial users. Of course,
it does not include sources of credit such as insurance companies or
other nondepository institutions.
The CHAIRMAN. Is there any way we can get a broader measure
of credit?
Mr. MILLER. I know you wrote to me about a broader concept of
"debt proxy" which would include the aggregate of all credits. I'm
not sure the Federal Reserve could influence that aggregate, since
most of the sources outside of depository institutions are also outside of any control of ours. It's a very interesting phenomena, and
one of our committees is looking at whether we should use the con-
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cept more. I appreciate your letter, which indicated there may be
some merit in our considering it.
The CHAIRMAN. Now you said in your statement that the Federal
~eser_ve welcomes President Carter's ~nitiative to help deal with
mflat10n and you have made some specific proposals with respect to
how that can be done and I think you recogmze that some of what
you propose wasn't very popular, particularly with Federal employees.
Now you're in charge of the Federal Reserve System which, according to the 1978 budget figures, employs more than 25,000 people
and will spend more than $840 million this year. It's a great place
to show by example how you can hold down spending. The Board's
budget allo-ws for an increase in salaries of more than 6½ percent
and the budget for the Reserve Banks where about 24,000 peopll'
are employed are budgeted for salary increases of 6.3 percent-far
·
above the President's 5.5 percent target.
Do you plan to cut these salary increases back to the 5.5 percent
figure the President says he wants Government employees to get in
October ,and will you have this cover both regular employees and
officers of the Board and the Reserve Banks ?
Mr. MILLER. Senator, as you know the salaries of Governors are
frozen so we don~t have to worry about that. We are appreciative 0£
your support to increase the executive level of Governors to level
No. 2.
The CHAIRMAN. As well as Members of Congress. They are keyed
to the same level.
Mr. MILLER. So we are taken care of there. But I do want to have
a program supportive of the President. You were talking about the
bud~et for this year. Of course, the President is talking about the
commg year. I want us to curb our expenses and cost increases and
salary increases in the current year and I certainly want us to go
forward next year in a manner supportive and consistent with the
President's goals; yes, sir.
The CHAIRMAN. Well, given the huge size 0£ the Federal Reserve
System's budget-it's just about as big as the congressional budgetwhy shouldn't the Congress have an annual prospective review of
your expenditures so we can judge alongside all other elements in
the Federal bureaucracy?
Mr. MILLER. I hope in your oversight hearings we are fully responsive to your reviewing our program. I believe an independent
agency, such as the Federal Reserve, operates more efficiently on the
time cycle that goes with our own planning and budgeting system.
As long as you see everything we are doing and can obviously call
us and bring us in at any point, I think you are getting everything
you need. I think our operation is more efficient doing things the
way we do them now.
The CHAIRMAN. Well, I must say, Governor Coldwell did a fine
job and a very impressive report. Compared with the Comptroller
and the FDIC, you were the star-your agency was-and I was
impressed by that, but still, that's far different-to get a historical
review with just being told what's been done-than every other
regulatory agency in Government where we have the responsibility
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of acting on the budget and determining whether or not expenditures
should go ahead or not go ahead and have an opportunity to debate
it and criticize it publicly and to have a direct accountability for
what's coming up.
You're in a very privileged position.
Mr. MILLER. Senator, I may be wrong, but I think our procedure
is to fix our budget and bring it before you before it is-The CHAIRMAN. No. I wanted to do that. I asked very much to
have the budget brought in. I tried to get the Federal Reserve to
come in-both the Federal Reserve and the Comptroller ,and the
FDIC said, no, they wouldn't come in before after the first of the
year. Then they told us what happened during the last year. ·
Mr. MILLER. You may have missed my pomt. I think you're absolutely correct. We fix our budget and bring it in to you for your
review. How much of that budget had been spent before you reviewed
it? Frankly, practically none. So you were looking at expenditures
prospectively, you were looking ahead to what was planned for this
year; you were not looking back at last year.
· The CHAIRMAN. But there was no way we could have any influence
.on it.
Mr. MILLER. Certainly there is.
The CHAIRMAN. No matter how outrageous we thought the expenditures were, we weren't in a position to determine by elected
representatives saying how much of the public money should be
spent by your agency.
Mr. MILLER. I respectfully disagree, because I think the words
of this committee are very weighty with the Governors and that if
you took exception with any major area we would go back and rework it very seriously. So I don't think that you are without clout
in influencing it.
The CHAIRMAN. Look at the difference there, Mr. Chairman.
You're very skillful. You say our words are very weighty. We had
a couple of Senators in here on both sides of the aisle asking questions and listening to the testimony-no vote, no examination item
by item, no consideration, no markup, no determination by the rest
of the Senate or by the House, no determination by the Appropriations Committee-just a hearing in which we were told what had
gone on and that was it.
Mr. MILLER. Senator, there may be areas in which we can make
the Federal Reserve operate better and be more responsive and more
informative. But if monetary policy is to be independent, I think
that oversight of this type is fully adequate and responsive. I fear
that any other process would really be an impingement upon the
independent monetary authority.
The CHAIRMAN. I was waiting for that because as you know I
think that your independence is certainly an independence of the
executive-no question of that-but the independence from the
Congress is something that I just keep coming back to-that marvelous direction that Paul Douglas gave William McChesney Martin,
"You are a creature of the Congress," because that's what the Federal Reserve is. We have the constitutional authority to coin money
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and regulate its value, not the Federal Reserve. We've delegated that
to the Federal Reserve. You are responsible to us. We are copping
out when we don't insist on going over this budget and have Congress review it and pass on it.
Let me ask, I understand S. 71, which has passed the Senate and
is pending in the House, provides a salary increase for the Chairman of the Fed to level 1. Are you in favor of dropping that provision now?
Mr. MILLER. I'm in favor of making it effective for my successor.
The CHAIRMAN. For your successor? That may be 30 years from
now.
Mr. MILLER. Even for the next term.
The CHAIRMAN. That's a more human and understandable response.
Mr. MILLER. After our freeze on executive salaries I would like to
see the other Governors raised to level 2 maybe a year from now,
but-The CHAIRMAN. That is recommended.
Mr. MILLER. I would do that a year from now. But I think for
the Chairman it should be done for the next term, because I don't
want to be here arguing for compensation for myself in the term
which I have agreed to serve. I don't know whether I will serve
another term or not.
The CHAIRMAN. As I understand it, the other members would be
raised under the recommendation.
Mr. MILLER. I think they deserve it.
The CHAIRMAN. From 3 to 2. That would be a substantial increase.
Is that consistent with your argument that Federal employees should
be held down to a 5.5-percent increase?
Mr. MILLER. I would freeze their salaries for the next year; I would
not make an increase effective until the following year.
The CHAIRMAN. All right. Mr. Miller, you said in your statement
that-yesterday Dr. Eckstein reported in his testimony that his
analysis indicates there's a zero probability that M1 growth would
fall below its lower bound of 4 percent in the next year and that the
same zero probability applies to the growth of M2 and its lower
bound 0£ 6½ percent. He also said that the Federal Reserve could
g¢t these low growth rates in M 1 and M 2 with a very restrictive
policy which would result in a Federal funds rate of 11 percent and
i very severe recession.
I doubt that you want that to happen, so it would seem to me that
the lower ends of M 1 and M 2 growth targets are simply unrealistic.
There's no chance you would get them, so why have them that low?
When you come in with a range as wide as 4 to 6½ percent, it isn't
very meaningful for the committee or the public. When we first
started taJking about having a target we pointed to the German
Bundesrat which had a specific numerical goal of 8 percent that
year and they come up with one figure. The Federal Reserve has
this range. Why shouldn't you be able to narrow that range to, say,
5 to 6½ percent?
Mr. MILLER. It's something we certainly will consider, Senator.
Perhaps we can. I don't know. Our economy is far more complex
than Germany's.
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The CHAIRMAN. Don't you agree that that 4 percent is wholly
unrealistic?
Mr. MILLER. It didn't look very unrealistic in the first quarter; we
were along the bottom of the range. It may be for the next quarter
bec.ause the strong growth of the economy will bring us back up in
the ranges. Ideally-ideally-the midpoint of 5¼ percent would be
the place to be shooting for.
The CHAIRMAN. Do you disagree with the Eckstein calculation
that if you had an M 1 of 4 percent that you would have an 11percent Federal funds rate?
Mr. MILLER. It depends on how long and when and where. For
example, I don't think we are going to have an 11-percent Federal
funds rate; Also, we had a 5-percent growth in the first quarter. So it
depends on what period you're talking about. If Otto had spoken 3
months ago, he would have been wrong, wouldn't he, because it
turned out we were at the bottom of our range.
The CHAIRMAN. It's over a full year. I think we recognize and
you recognize as well that these things fluctuate from quarter to
quarter, but over a full year he made that calculation.
Mr. MILLER. I can tell you about precedents. When we came out
of the recession in 1975 we were in the lower end of the ranges, and
we didn't have the funds rate going off the charts. So I think you
have to be careful with those kind of blanket statements. I don't
want to see the funds rate at 11 percent. I don't want to see a recession. On that I will agree with you.
The CHAIRMAN. Now let me come to this chart. I'm just about
through here. For the past several years the Open Market Committee has given the manager of the open market desk explicit target
ranges :for M 1 , M 2 , and the Federal funds rate for the policy period
between Open Market Committee meetings. The Fed's record in hitting those targets for M1 is terrible, as you can see :from the top
chart. You missed more than half the time, as can be seen on the
chart. Yet the desk managed to peg the Federa1 funds rate within
the desired range consistently, I think, without exception, remarkably, and right in the center almost every time, in the lower chart.
Now I take it that you will still use this procedure and given the
disastrous experience with it I'm curious why you continue to operate in that manner, why the adherence to the M1 and M 2 target in
view of the fact that you have been so far off.
Mr. MILLER. Given the upper panel of your chart, it might be well
to forget those targets; we'd look better. But I think this is something that does need to be reexamined, and some of the members of
the FOMC have recently been submitting suggestions to us on how
we might operate differently.
The CHAIRMAN. Let me suggest what this looks like to me is that
there will often be an inconsistency between hitting the Federal
funds rate target and hitting the M1 target and what your people
do is to aim for the Federal funds target and hit it and in doing so
that's what happens at the top. If they aim for the M 1 the Federal
funds rate would be missed.
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Mr. MILLER. Of course, the short-term ranges are guides for the
Federal funds rate. The directive, as you will notice, ends up by
sa;Ying that a particular Federal funds rate is consistent with a certam expectation; if the money supply should go outside of that,
then the desk should act accordingly. I think there's an intermesh
between the two. The Federal· funds rate has been considered the
item that can be handled and controlled; M 1 is more unpredictable.
But I see your point. We shall go forth and try to do better.
The CHAIRMAN. Well, I do think-and, of course, I have great
respect for the Federal Reserve. You've got a marvelous staff there,
very fine, able people, but I think this does undermine its credibility
and certainly doesn't do a favor to the Nation's banks and the other
people in the financial area ·who have to operate on the basis of what
the Federal Reserve is trying to do and then sees it miss so badly
that they feel they can't count on a consistent, competent, effective
monetary policy.
Well, I want to thank you very, very much, chairman Miller. You
and I have had our differences, but I think you have been an excellent witness, a most intelligent and thoughtful and responsive witness.
Mr. MILLER. Senator, I appreciate this opportunity to be here. I
enjoyed it. I appreciate your courtesy. I look forward to being back
in a few months.
The CHAIRMAN. Thank you very much.
The committee will stand adjourned.
[Whereupon, at 12 :20 p.m., the hearing was adjourned.]
[Additional material received for the record follows m the appendix.]
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APPENDIX
POLICY STATEMENT
SHADOW OPEN MARKET COMMITTEE
March 13, 1978
A declining dollar, a falling stock market, and rising long-term interest
rates describe the reaction by financial markets, at hJme and abroad, to our
government's actions. Currently the nation does not have an economic policy
to reduce inflation, balance the budget, and encourage investment growth and high
employment.
The stock market, the bond market, and the foreign exchange market shout
their disbelief at our government's statements about increasing investment,
reducing inflation, balancing the budget, or supporting the dollar. They fear
a drift to controls, a reliance on stopgaps, and increased inflation.
The Shadow Open Market Committee repeatedly has urged the Federal Reserve
and the Administration to recognize that the nation's problems are long-term
problems that cannot be solved by fine-tuning and by stopgap approaches. A
policy that looks ahead years, not weeks or quarters, is what is required. Last
year this Committee warned that the policies then proposed and subsequently
adopted would have the inflationary consequences now apparent to all. This year
we urge again that a long-term program be adopted and adhered to.
The problems the nation faces are not intractable. They seem intractable
only because the government continues to seek short-tenn solutions to long-term
problems and acts on the false presumption that inflation will not increase as
long as resources are counted as unemployed. Such presumptions lead the
Administration to solve every problem by pumping up short-term spending and to
understate the role of incentives to output and capital formation
not only
tax incentives, but also reduction of business uncertainty caused by accelerating
inflation.
Promises to defend the dollar, increase investment, balance the budget, and
lower inflation cannot be met if the primary aim of policy is to stimulate shortterm spending. Current policy will produce higher inflation, but not the high
level of investment the Administration seeks to restore growth of income to the
long-term potential of the U.S. economy.
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What Has Been Done?
Last year the Carter Administration gave up the commitment to balance th,i
budget by 19Bl. The Federal Reserve failed to carry out its announced policy
of reducing the growth of money. The budget deficit remained high in 1977 and
continues high in 1978.
The growth of money stock -- currency and demand deposits -- exceeded 7%,
a rate last seen in 1972 and 1973, just before the major inflation began. Th,ire
is cause for alarm in the continuation of so high a growth rate. No less alacrning would be an abrupt reduction of this growth rate. The policy of reducing
unemployment first and reducing inflation later has created the expected dilemma.
We cannot expect real investment to reach the growth rates of the 1960's if
large budget deficits, highly variable monetary policies, growing restriction,
on trade, and misguided policies on energy continue. We cannot expect a more
stable exchange rate for the dollar until policies become stabilizing. We cannot expect inflation to slow following a period of sustained increase in money
growth from 4.4% in 1975, to 5.6% in 1976, and to 7.4% in 1917. We cannot expect
to avoid recession in 1979 if monetary policy shifts suddenl I to combating inflation.
Because of the excessive monetary growth th,1t was permitted in 1977, anticipations of future inflation are heightened, and interest rates are rising. T,1
minimize the adverse effects on savings flows to thrift institutions, Federal
ceilings on interest rates on consumer deposits should be abolished or raised.
These price controls have never served a useful purpose and have done far too
much damage. We commend Chairm~n Miller's recent initiative in this regard.
Last year this Committee warned the Federal Reserve that monetary growth in
excess of the announced targets would be detrimental to the durability of this
economic expansion. The members of the House Banking Committee cautioned the
Federal Reserve to maintain monetary growth within its own announced target
ranges. The Federal Reserve did not heed the advice that was given. A mistake
in economic policy was made, and now a price must be paid to correct it.
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What Should Be Done?
The policy of gradualism brought the increase in consumer prices down
from the very high rates of 1973 and 1974 to an average of 4.5% in the last six
months of 1977. The economy recovered. The dollar exchange rate remained stable.
If we had avoided the burst of government spending and excessive money growth last
year, we would have continued to receive the sustained benefits that can only be
achieved if government policies are stabilizing. Excessive stimulus last year
has continued too long to be abruptly halted.
We propose four steps:
One, the rate of monetary expansion in the ,,ast year was between 7% and 7.5%.
We urge that the rate be maintained at 6% in 197,:.
Two, we recommend reductions of 1% a year in the average rate of monetary
expansion until a noninflationary rate of monetary expansion is achieved. The
Federal Reserve should commit monetary policy to this s tabil i zing long-term
monetary course in order to fulfill its legal rP·,ponsibilities under the Federal
Reserve Reform Act of 1977.
Three, the Congress should implement the Administration's pledge to reduce
the growth of government spending below the growth of private spending during the
next three fiscal years.
Four, to encourage investment and output, the Administration and the Congress
should reduce all tax rates, individual and corporate, to offset the full effect
of inflation on taxpayers. Real taxes in future years should be no higher than
they would have been if there were no inflation.
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SHADOW OPEN MARKET COMMITTEE
The CoITrnittee met from 3:00 p.m. to 10:00 p.m. on Sunday, March 12, 1978.
Members:
Professor Karl Brunner, Director of the Center for Research in Government Policy
and Business, Graduate School of Management, University of Rochester,
Rochester, New York.
Professor Allan H. Meltzer, Graduate School of Industrial Administration,
Carnegie-Mellon University, Pittsburgh, Pennsylvania.
Mr. H. Erich Heinemann, Vice President, Morgan Stanley &Company, Inc. New York,
New York.
Dr. Homer Jones, Retired Senior Vice President and Director of Research, Federal
Reserve Bank of St. Louis, St. Louis, Missouri.
Dr. Jerry Jordan, Senior Vice President and Chief Economist, Pittsburgh National
Bank, Pittsburgh, Pennsylvania.
Dr. Rudolph Penner, American Enterprise Institute, Washington, D.C.
Professor Robert Rasche, Department of Economics, Michigan State University,
East Lansing, Michigan.
Professor Wilson Schmidt, Department of Economics, Virginia Polytechnic
Institute, Blacksburg, Virginia.
Dr. Beryl Sprinkel, Senior Vice President and Economist, Harris Trust and Savings
Bank, Chicago, Illinois
Dr. Anna Schwartz, National Bureau of Economic Research, New York, New York.
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Federal Reserve Bank of St. Louis
January 1978
MONETARY POLICY AT A CROSSROAD
By Ronald H. Marcks
My name is Ronald Marcks. I am a lawyer from Lincoln, Massachusetts,
speaking as a private citizen.
My qualification for giving this statement is having studied and written on
the subject. A book I published four years ago, for example, had the distinction
of correctly predicting the double-digit inflation then and is still correctly
predicting the inflation now.
(The name of the book, incidentally, was "DYING OF MONEY: Lessons of
the Great German and American Inflations,'' published under the nom de plume
of Jens 0. Parsson.)
There should be no question that we stand at an important fork in the
economic road right now. Unfortunately it is not a propitious one.
The present economic situation can be summed up in just these few words:
the rate of expansion of the money supply (M.i) has now risen well over 7%
on a year-to-year basis, increased over the course of 1977 from only about 5%
prevailing throughout 1975 and 1976. That 7%-plus current rate is within a
percentage point of the highest year-to-year rate seen at any time since World
War II. (The high points of about 8% were touched momentarily in 1971 and
again around the end of 1972. )
The two-point rise in the rate of money expansion that occurred during 1977
is the paramount economic fact at the present moment. No assessment of the
economic situation can make sense without taking account of it. Past experience
tells us without any equivocation that that rise in money expansion has these
meanings:
First, the underlying base rate of inflation was also raised by two full
percentage points by it.
Second, 1977 was made a substantially better year economically than it
otherwise would have been by this stimulus, though the benefit was artificial
and temporary.
And third, if the rate of money expansion does not continue to rise even
higher, the stimulus will soon have dissipated (if it has not already) and the
economy must increasingly turn sour.
Monetary policy needs to face up to two sets of very clear but not very
well recognized inferences from the economic events of the last thirty years.
One set has to do with the inflation side of i:he problem, and the other set with
the stagnation side.
On the inflation side, it is an undeniable fact that rising prices have matched
the expansion of the money supply to within a fraction of one percent per year
over the 28 years since 1949, when a stabilized postwar condition prevailed.
Prices are still doing so today and give every sign of continuing to do so in
the future. That correlation held good not only over the entire 28-year span
but also over each of three distinct cycles within the period. The figures are
these:
AVERAGE ANNUAL INCREASE
(In percent)
1949 to 1953 ________ -- -- ------ -- -- -- -- -- ---- -- -- -------- _________ _
1953 to 1962 ________ ---------------------------- _________________ _
1962 to 1975 ________ -- ---- __ -- ---- -- -- ---- -- -- -- _________________ _
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Federal Reserve Bank of St. Louis
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Money
supply
Wholesale
prices
Difference
4, 2
3.6
.8
4. 9
0.6
.6
.4
1.4
5. 3
188
Thus, whether the absolute rates of rise were high or low, inflation always
averaged only about half of one percent per year less than money supply expansion. This has continued. Over the two full years 1975 and 1976, money
expansion averaged 5.1% and price inflation 4.5%, still maintaining that fraction of a point difference.
The clear inference is that every percentage point of increased money supply
is good for just about one point of inflation, no more and not much less. We
have a high inflation rate now simply because we have a high rate of money
supply expansion; there is no chance that inflation can ever be reduced as
long as money supply must expand so fast; and if we let the speed of money
supply expansion increase any further we shall have still faster inflation.
To help visualize this, the accompanying chart presents wholesale prices for
the 28 years plotted against money supply adjusted by subtracting that apparently noninflationary component of one-half of one percent per year. The
appearance in this chart that prices were always gravitating toward the
equilibrium set for them by money supply is inescapable.
The most striking feature of this chart is the wide gap between money
supply and prices which opened and then closed over the period from 1962 to
1975. The double-digit inflation which closed the cycle, being much faster than
the money expansion then prevailing, perplexed everyone, but it is not at all
perplexing if we look all the way back to the beginnings of the cycle in 1962.
In 1962, money supply and prices were in apparent equilibrium with each
other. Both had been edging up no faster than about 1% per year, on average,
for ten years. Then, in the fall of 1962, there began a sharp acceleration in the
rate of money expansion to the range of 5% or more which has been sustained
ever since. For the next few years, prices were slow to begin rising as fast
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Federal Reserve Bank of St. Louis
2.5
0
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Federal Reserve Bank of St. Louis
...-·
.
_,
I
2.0
I
f
I
-·•
'
,,
,.
I
,..-·
Money supply adjusted
(reduced 0.5% per year)
.
.'
- - - - - Wholesale prices
1.5
I
, ·'
•
, .... ,.
,
.·
.
----·
-
~~-.-.--~-.------,-..--,--,--,--.--,------,--,--,--,--r--,- -,-~,--,--,---,--r---r-;-r-.--r-1.0
1950
1960
1970
1978
190
as money supply because of the inertia built up over the preceding ten years
of stability, and as a result the gap opened. It can be inferred that money
supply and prices were moving increasingly out of equilibrium, and that the
whole gap was latent inflation which must be realized sooner or later before
equilibrium could be restored.
That same temporary ability of money supply to increase faster than prices,
thereby creating real purchasing 'power out of thin air, was also the sole foundation for the unprecedented prosperity while the gap was opening, from 1962
through 1968. Most of the double-digit inflation to come was already latent by
the end of 1968.
Inflation gradually picked up speed in pursuit of money supply, briefly
checked by tight money spasms and by price controls, until at last the doubledigit inflation broke out in 1973 and 1974 and ran just long enough to close
the gap. When it had done so, at the beginning of 1975, equilibrium was regained and inflation subsided for no apparent reason to about the same speed
as ,money expansion.
from the moment the money expansion accelerated in 1962, something like
the double-digit inflation of 1973-1974 was guaranteed to be the conclusion.
The early boom and the late inflation had the same cauSP,, namely the money
expansion. At all times after 1962, the inflation to come could be mathematically
predicted simply by comparing the"total inflation with the total money expansion since the last equilibrium in 1962, and that was how I did correctly predict the double-digit inflation.
It is not at all difficult to understand how money supply can exercise such
a controlling influence over inflation. Money supply directly determines the
total amount of purchasing power in use, which is nothing more than money
supply multiplied by its rate of turnover, or "velocity". For example, $300
billion of money supply turning over, say, 59 times a year would produce total
purchasing power of $15 trillion per year. Total purchasing power spread over
all tb,e things to be bought with money must necessarily determine the money
prices of all the things, and those prices are what determine inflation or the
absence of it.
It may well be asked how it is possible for virtually every percentage point
of increase in the money supply to be inflationary, as it has been, when a substantially growing money supply would seem to be needed just to service the
natural growth of the economy. The answer likes with money velocity, that
other factor in total purchasing power. Velocity alone has increased as fast or
faster than the economy throughout the 28 years and is doing so now. In 1949,
the average dollar of demand deposits turned over only 20 times a year, compared with 153 times in 1976, which works out to an average compound increase
of more than 7% per year. By that acceleration, velocity supplied virtually
all the additional purchasing power required by real growth, and any increase
in money supply itself on top of that was bound to be inflationary. The common
notion that money supply may increase as fast as real growth without causing
inflation is therefore completely and dangerously false.
So there really is no reason to doubt the plain appearance that every point
more of money supply is good for one more point of inflation.
This then explains what has happened to inflation over the past year and
what is going to happen next. Up to the end of 1976, inflation was firmly
stabilized at around 5% by a rate of money expansion which was also constant in that vicinity. Then came that two-point rise in 1977 to a money expansion rate which is now more than 7%. Inflation inevitably rose too. When
it fully catches up and stabilizes again, it is sure to be close to 7% itself. For
the last few months of 1977, the rate of money expansion paused in its ascent,
and if it permanently levels off near 7%, so will inflation. If it resumes increasing, so too will inflation. It is as simple as that, as far as inflation goes.
The basic idea that money supply has something to do with inflation is not
a new one. It dates from at least as far back as the ancient Greeks, but it is
far from being generally accepted now. No present-day economic analysis to my
knowledge has recognized the point-for-point identity of inflation with money
supply over the last thirty years. Most current analysis takes hardly any account of the money-supply basis for inflation at all. Most current efforts to find
ways of coi;ttrolling inflation focus on deterring sellers and workers from raising their prices or wages so rapidly. Those are much the same ways the Em-
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peror Diocletian tried more than sixteen hundred years ago. He .failed then,
those methods have failed every other time they have been tried, and there is
no reason to think they can avoid failing now. No price or wage can increase
if there is not the .purchasing power to pay it, but if there is the purchasing
power, no power on earth can for long keep it from rising. Money supply is
what determines the purchasing power.
I do not mean to imply that inflation is the only problem we have, or even
necessarily the most serious one. Without a doubt it is possible to live with an
inflation like the present one indefinitely. Obviously it is possible, because we
are doing it. We shall probably have to continue doing it. My effort is merely
to identify the factual reasons why we have this inflation rate, under what
circumstances it will go still higher, and why it is practically impossible for it
to go lower.
So much for inflation.
Meanwhile. on the stagnation side of the problem, it has been equally clear
that money supply again calls the tune. Over those 28 years since 1949, growth
of gross national product (GNP) has conformed to the rate of money expansion just as obediently as inflation did. The accompanying chart, plotting
against each other the growth rates of GNP and money supply year-to-year
( total increase since the corresponding point a year earlier), shows this.
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GNP
+
5%
Money supply
+
5%
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1950
1960
1970
1978
193
In this chart, it is readily apparent that the ups and downs of GNP growth
matched those of money supply growth..to an uncanny degree. Every peak rate
of GNP growth corresponded with a peak rate of money expansion, and every
trough in money expansion corresponded with an economic slowdown or recession. There was no instance in the 28 years in which GNP failed more than
temporarily to move in the same direction as the rate of money expansion,
regardless of any other influences such as increased or decreased taxes or
budget deficits.
There has been no case in which GNP growth succeeded in rising without a
rising rate of money expansion. Worse yet, there has been no case in which
GNP growth even succeeded in sustaining itself at a reasonably high level
without a rising rate of money expansion. A non-rising rate of money growth,
even though high and therefore inflationary, always produced declining GNP
growth until it stagnated at a very low level. There have been no exceptions.
From what we have already seen about inflation, the implications of this
are somewhat serious. Stagnation is the natural equilibrium condition whenever money supply expansion is not increasing. There is no way to accelerate
the economy without more money expansion, while there is also no way to
have more money expansion without more inflation. No matter how high the
inflation rises, stagnation will come any time it stops increasing. It makes no
difference-it never has-whether taxes, deficits, or government spending are
raised, lowered, or left alone. No stimulant has ever worked. except faster
money expansion, but that one, when used, has always caused faster inflation.
Moreover the stimulation has always been temporary while the increased inflation is permanent. None of this is likely to change until we find some new
tools.
·
If we can grasp all this, the present situation becomes much clearer. After
the last recession bottomed out at the beginning of 1975, that steady money
expansion of 5% per year for the next two years initially allowed a spontaneous recovery to occur. That recovery was, however, nothing more than a
reflexive bounce from an overcontracted condition, and it was short-lived. The
recovery peaked in the first quarter of 1976, after which GNP growth fell
steeply in each succeeding quarter until it was near zero by the end of 1976.
This was the well-remembered ec~nomic "pause." The natural equilibrium associated with a permanent stabilized inflation was beginning to emerge. If the
rate of money expansion had continued to stay constant at 5%, the inflation
would have done so too and the looks of the final equilibrium would surely
have become clear by now. In all probability, that final equilibrium rate of
GNP growth would have been quite poor.
But the rate of money expansion did not stay constant. The emerging equilibrium already looked poor enough, and the two-point rise in money expansion
which began in December 1976 quickly chased it away. The year 1977 was
thereby improved markedly over both late 1976 and what its own unstimulated
condition would have been like. All the improvement was attributable to that
two-point increase in the rate of money expansion.
Now the monetary stimulation is past. Its effects both good (stimulation)
and bad (inflation) have probably been realized for the most part already. The
stimulation was temporary, while the increased inflation is permanent. Again
the rate of GNP growth has been dropping in every quarter since the first of
1977, though not yet as low as in 1976. That natural equilibrium, whatever it
would ultimately be like, seems to be coming again. That presents the question
of what to do next. That is the nature of the crossroad at which we stand.
At this juncture, if the rate of money expansion does not rise any further
but remains constant around its present 7%-plus, the inflation will also stabilize near its present high rate but the threatening natural equilibrium will
surely arrive in due time and stay. GNP growth will continue falling until it
finds its natural level and stabilizes there. There might be recession for a
while, or there might only be persistent slowdown. The final natural growth
rate would almost surely be low, probably less than 4% and quite possibly
closer to zero. It would be permanent as long as money expansion was kept
from rising, while on the good side there would also be no further tendency
to fall off in to recession.
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On the other hand, if at this juncture the rate of money expansion does rise
auy further, we may obtain easier eco•omic conditions as long as the rise continues but we will also have constantly increasing inflation. If the rate of
money expansion should actually decrease, the inflation would be reduced a
little but we would also, have immediate recession. All of these probabilities
are amply evidenced by past experience, and there have been no contrary experiences. Obviously none of these alternatives is attractive, but they are all
that are open at the moment.
It is no more difficult than with inflation to explain how money supply can
exercise such a controlling influence over growth and prosperity. Again the
secret is total purchasing power, which is determined by money supply. No one
can buy any more economic activity, regardless of the highest of confidence or
the most exuberant of spending intentions, if he has no more purchasing power
for it. Only increased money supply can provide the purchasing power to lift
economic activity above whatever its natural level would otherwise be, and
then only until the inevitable inflation robs the real value of the fresh purchasing power.
Here again, the idea that money expansion has something to do with economic growth is not new. Monetarists have been saying it for years. But it is
not accepted any more than the relationship with inflation is accepted. No
observer to my knowledge has recognized the apparent fact that stagnation
is the unavoidable equilibrium of a non-rising money expansion. Most observers
clo not even accept the primary influence of money expansion on prosperity.
J\lost current efforts to find ways of stimulating the economy focus on the traclitional fiscal tools of tax cuts or increased government spending and deficits.
In 30 years, however, there has not been a single instance iu which auy of those
measures did in fact stimulate the economy in the absence of rising money expansion. There is no reason why they should, since tax cuts and increased
cleficits merely reallocate total purchasing power among different sectors of the
economy without increasing the total. So there is also no reason to expect fiscal
measures to stimulate the economy now any more than they have ever done
in the past.
I certainly do not wish to leave the impression that all is hopeless, even
though I do say that the familiar fiscal and, monetary tools are either useless
or suicidal. Undoubtedly it is possible to devise effective ways to obtain full
employment, abundant prosperity, and zero inflation all at the same time. It is
just not as simple as the fiscal and monetary ways we know. Our real problems
are rooted deep in gross deformities of the ways we divide up our incentives
and rewards. We are not about to cure the problems until we are willing to
let major surgery be performed on those structural deformities. ,ve cannot even
begin to talk usefully about real cures until we forget about the easy fixes
of fiscal and monetary stimulation ouce and for all.
From the present crossroad, there are only those three possible paths: faster
money expansion, no faster money expansion, or slower money expansionwhich is the same as to say constantly rising inflation, chronic stagnation, or
recession. Of these, the least bad would seem to be to stop the rate of money
expansion permanently from rising any higher and accept whatever conditions
that .brings while we go looking for some new economic tools. But that is just
my judgment, on which others may differ.
Whichever course we choose, we should be under no illusions about the consequences that will follow, and we ought to be frank with ourselves about which
of the unpleasant alternatives we are electing. History gives us plenty of warning that every point more of money supply will be good for one more point of
inflation, while on the other hand if we do not have faster money supply expansion we shall stagnate. No other expectation for the future conforms to the
plain facts of the past.
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m
BANKoF AMERICA
A. W. CLAUSEN
President
May 17, 1978
Dear Jack:
I'm pleased to respond to your request for my conunents on your
statement of appropriate policies to meet four pressing problems
facing our country: inflation, productivity, unemployment, and
exports-imports imbalance.
I certainly agree with the constructive tone and substance of
your policy proposals. I applaud the "conunon sense" emphasis you
suggest, and particularly, the objectives to achieve many desired
results over five years. You are, of course, in a much better position
than I to judge how feasible this approach will~be in the Congress.
My principal concern is that the Congress and the Administration
recognize that our nation now faces a confidence problem at least as
much as an economic problem. Complex, impractical remedies and
regulations which divide or frustrate our people only intensify
public anxiety and confusion.
Straightforward small income tax cuts over a period of time
can be readily understood, minimize revenue losses, reward risktaking
and greater human-effort, and gradually help restore confidence,
if government spending is held in check.
Policy target numbers can be useful, but in the field of interest
rates and finance with which I am most familiar, experience demon-
strates that market forces cannot be dammed up very long without
major disruptions adversely affecting the public, as well as business
and government. As you know, we're now marketing variable rate
mortgages in California.
BANK OF AMERICA NATIONAL TRUST ANO SAVINGS ASSOCIATION · BOX 37000 · BANK OF AMERICA CENTER ·SAN FRANCISCO.CALIFORNIA 94137
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196
In my view there is growing public demand for more accountability
in actual cost-benefits from government regulators and administrators,
not unlike the results-oriented procedures widely used in business.
Your attention to U.S. trade and payments imbalances is timely.
Our future international relations and the value of the dollar are
at stake. We must, as you say, make far better use of our domestic
energy resources. I would add that we must make a more determined
drive to expand exports.
I agree that all these issues are interrelated, but the fundamental question is whether we have the national discipline to correct
our fundamental problems. With traditional U.S. public collllllon sense
and effective leadership from public officials such as yourself, I
remain confident that our country will soon turn a corner toward
greater economic balance between investment and consumption against
a background of fiscal and monetary restraint.
You can count on our interest and support.
(LL_cerely,~
.
f[;?h:usen
President
Honorable Harrison Schmitt
United States Senate
Washington, D.C. 20510
BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION
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DATA RESOURCES,
I NC.
29 HARTWELL AVENUE· LEXINGTON • MASSACHUSETTS 02173
6t<l._/ 861-0165
OTTO ECKSTEIN
May 15, 1978
Senator Harrison Schmitt
New Mexico
United States Senate
Washington, DC 20510
Dear Senator Schmitt:
Thank you for sending me your comments of the hearings of monetary policy.
I share your general perspective and goals although there will inevitably be some
differences in the nuances. I am delighted that the Senate and the Committee
have added another member with a serious interest in the problems of the economy.
Inflation: Your budget proposal is generally similar to those advanced in my testimony. I am not sure it is safe to legislate tax reduction on a $10 billion per year
basis without some safety valves because there could be special situations in which
one would wish the taxes to go down a little faster, or in which foreign exigencies
or severe inflation dangers would require the taxes to be held steady for a year.
I certainly share your view that the rate of growth of the Federal budget must
be slowed.
On the Federal funds rate limit of 796, it is already too late, with the Federal
Reserve having moved to 7¼%, and with apparently higher rates ahead. I do not
believe it will be possible for the Federal Reserve to bring the growth rate of
Ml down by ½% a year without creating a financial disturbance. I believe in variable interest rate mortgages, and, as I expressed at the hearing, believe that
management and labor must share in the process of reducing the inflationary spiral.
Productivity: I agree with all of your measures to boost productivity including
a reshaping of tax policy with regard to export stimulation. We are now putting
tax money into this field without much benefit. We should do it better.
Unemployment: I agree that tax policy should be used to encourage employment
and with some special emphasis for small business and labor-intensive production.
The challenge in this field of employment credits is to set up the program so it
really produces incremental employment. I doubt that the present employment
credit does very much along those lines.
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I also agree with you that welfare reform must be set up to encourage people
to work, with emphasis on private sector employment. We are doing so much
now on public service employment it is time to bring in more private sector incentive.
Export/Imports Balance: I agree that our trade balance really must be improved,
and this must include both conservation and increased production of energy.
Whether I would favor a national trade policy coordination commission would
depend upon the function of this group. I am quite suspicious of coordinating
commissions,. the Department of Commerce really should be doing this job anyway.
Thank you for inviting my views.
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Sincerely yours,
199
FAIRFIELD
LNIVERSllY
NORTH BENSON ROAD, FAIRFIELD, CONNECTICUT 06430
■
rAY I '
(203) 255-5411
I;'rr
May 16, 1978
Senator Harrison Schmitt
Committee on Banking, Housing
U.S. Senate
Washington, D.C.
20510
&
Urban Affairs
Dear Senator Schmitt,
Thank you for the copy of your statement on
April 25, 1978 before the Senate Banking Committee.
As you requested, I am sending along my
comments on some issues you raised.
I hope they
will provide some insight.
Yours truly,
Joan G. Walters, Ph.D.
Professor and Chairman
Economics Department
el
Enclosure
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Comments on Senator Harrison Schmitt's Statement
of April 25, 1978
Joan G. Walters
INFLATION:
Senator Schmitt's Statement rightly emphasizes that a tax
cut should be accompanied by a spending cut.
Since a tax cut is
planned, it is well to specify that spending cuts must be undertaken simultaneously.
Over the longer term,
budget expenditures should
G.N.P. If this balance is
government in the economic
the rate of growth of the federal
be linked to the rate of growth of
not reached, the relative role of
system will continue to increase.
PRODUCTIVITY:
Fostering investment in plant and equipment and the development and introduction of new technology should be a primary objective of government policy. During the hearings on April 24, 1978,
fears were expressed concerning equipment replacing workers, thus
raising the automation spectre--capital versus labor. A positive
approach envisions capital as raising the worker's productivity,
and hence wages. All the new entrants to the labor force (both
baby-boom workers and women) must be provided with additional
capital goods in order to raise total productivity.
It is time for government economic policy to promote the
efficiency goals of society in terms of increasing output and
jobs. Equity goals involving income redistribution have received
the primary emphasis for the past fifteen years. Government policies to foster increased growth and greater incomes again must be
considered a top priority.
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Senator HARRISON SCHMITT,
U.S. Senate,
Washington,
J. HENRY SCHRODER BANK & TRUST Co .•
New York, N.Y., May 23, 1978.
D.a.
DEAR SENATOR SCHMITT: In answer to your letter of May 5 in which you enclosed a statement of what you believe to be the major economic problems facing
the U.S. today, I generally concur with your comments. If I were to make my
own list, I probably would have added two other factors in addition to inflation,
productivity, unemployment and the export-import imbalance. The first would be
a lack of coordination between monetary and fiscal policies and second would be
the inability to control fiscal policy. Moreover, it is not merely control over fiscal
policy that is disturbing, it is an inability to make accurate forecasts of the numbers, to understand the ramifications of the numbers, and to have the flexibility
to do something about it. There are also other factors that I would look at because I find them of great importance. I have recently written an article on some
of these topics which will shortly appear in "The Money Manager" and I am enclosing a draft copy.
As for your comments on one of the major problems that you listed, I have
the following thoughts :
1. lnftation.-1 concur with the idea of reducing Government spending now,
but I would delay somewhat the tax reductions until there is clear evidence that
the deficit is heading downward not upward. With respect to monetary policy, I
want to point out that the Federal Reserve can hold down the Fed funds rate
and the money supply simultaneously only if the underlying forces in the economy allow the l<'ed to do so. However, if pressures build in the economy, one or
the other may have to be sacrificed. Also, the relationship between the quarterly
growth in M-1 and GNP is highly imperfect, first because the statistics are imperfect and subject to major revisions and second because M-1 can grow in
either amount or in turnover ( volocity), yet the published M-1 figures show only
the amount.
2. Productivity.-! contend that "cost" should be studied thoroughly before
regulations are imposed because in many cases costs spring up in unexpected
areas, often with a time lag. For example, unduly low prices on natural gas
created a major cost in terms of gas being flared, 1ack of exploration, and the erroneous belief by many users that gas would be relatively inexpensive and always available in sufficient quantities (and constructing facilities on that basis).
3. Unemployment.-Too much emphasis is placed on a single desired level of
unemployment. Emphasis instead should be placed on growth targets for employment and how they may be achieved. This growth target would vary depending
upon economic, social and demographic circumstances. For example, what would
be wrong with having as a prime target an II ttempt to put between two million and
three million people to work in 1978 rather than aiming at a specific unemployment rate where the sample is small and people seem to move rather freely in
and out of the Jaber force. If growth in em;ployment is used as a target, it can
then fit in quite nicely with business tax incentives that can be used to achieve
employment growth.
4. Export-Import Balance.-A National Trade Policy Coordination Commission
is an excellent idea. In addition to other excellent points you made in this area,
I would suggest that the Government further stimulate exports while reducing
the benefits of U.S. corporations sending capital abroad.
I enjoyed testifying before the Senate Banking Committee and hope that the
comments I made before the Committee as well as the suggestions enclosed in this
letter will be useful in designing public policy.
Sincerely,
DR. LEONARD J. SANTOW.
28-083 0 - 78 - 14
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STATEMENT
on
APPROPRIATE MONETARY POLICY
for submission to the
SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
for the
CHAMBER OF COMMERCE OF THE UNITED STATES
by
Dr. Jack Carlson*
May 18, 1978
The Chamber of Commerce of the United States appreciates the opportunity
to share business' concern about the Government's proposed economic policy for the
next twelve months.
We recommend a somewhat different economic strategy than is
implied in a moderately restrictive monetary policy and a fiscal policy that is
expansionary on the spending side.
RECOMMENDATIONS
We support the current monetary policy that involves no lowering of the
Federal Reserve 1 s· monetary growth rate ranges for M-1, M-2, and M-3.
But we are
concerned that Federal Reserve credit restraint if pursued too vigorously could
cause the federal funds rate to increase significantly abot"e 7¼% which, in
conjunction with heavy Treasury cash borrowing, could cause a credit crunch which
would cripple housing and small business, and increase the chance of a recession
next year.
Therefore, the Chamber recommends placing more of the burden of fighting
inflation on the back of fiscal policy and less on oonetary policy.
This would
best be done by limiting FY 79 federal spending to $490 billion instead of the
$500 billion proposed by the Administration and the $499 billion proposed by the
first concurrent budget resolution.
The smaller spending total would still be an
increase of nearly $38 billion over the FY 78 figure and would represent a $630
increase for the average family.
* Vice
But at least the proposed FY 79 deficit would
President and Chief Economist, Chamber of Commerce of the United States
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203
be reduced instead of increased from $53.0 billion in FY 1978 to $59.6 billion in
FY 19 79, as now proposed.
We recommend against shrinking tax relief.
Tax relief should be maintained
at $24 billion, with a larger proportior of tax relief to encourage job-creating
investment~
Investment in the near term can be encouraged best by providing tax
relief, first, in the form of a higher investment tax credit, second,.i more favorable
treatment of capital gains, third, more adequate depreciation allowances,
fourth, Corporate Income Tax rate reductions, and, fifth, Personal Income Tax rate
reductions.
Unne~essary uncertainty and needless additional _inflation-boosting costs
should be avoided by maintaining the same level of expenditures for federal
regulations in FY 1979 as in FY 1978.
ECONOMIC OUTLOOK
Now that the first quarter pause is behind us, real growth should rebound
in the second quarter and fluctuate between 3 to 4% from the Summer of 1978 through
the end of 1979.
This forecast is somewhat less optimistic than the
Administration's (see Table l).
TABLE l
ADMINISTRATION AND CHAMBER FORECASTS
1979
1978
Without
Tax Relief
Chamber
With Adm.
Tax Relief
Chamber
Carter
Without
Tax Relief
With Adm.
Tax Relief
Chamber
Chamber
Carter
GNP, adjusted for
inflation
3. 7%
3.9%
4. 7%
3.2%
3.9%
4.8%
Consumer Price Index
6.6%
6.8%
5.9%
6.4%
6.6%
6.1%
However, the Chamber's forecast has been more accurate than the
Administration's forecast (see Table 2).
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TABLE 2
ADMINISTRATION RECORD ON FORECASTING
Forecasts made
February 1977 for 1977
Carter*
Chamber
Actual
for
1977
Differences between
Forecast and .Actual
Carter*
Chamber
Real GNP Increase
5.4%
4.9%
4.9%
+o.5%,
None
Consumer Price
Increase
5.1%
6.5%
6.5%
-1.4%
None
*Fiscal Year 1978 Budget Revisions, February 1977.
Tax relief of $24 billion is fully justified, effective October 1, 1978,
It would add about three-quarters of a percentage point to real GNP growth, add
very little to inflation and create about one-half million new jobs by the end of
FY 1979 (see Table 3).
TABLE 3
EFFECTS OF $24 BILLION TAX RELIEF
1979
Real GNP
Consumer Price Index
Jobs
+o.7%
+0.2%
+500,000
Tax relief should not be sacrificed for gluttonous federal spending.
If no tax relief were provided, federal taxes would increase by a record amount,
$64.6 billion, 16% or $1,077 for an average American family.
Even after providing
$24 billion in tax relief, federal taxes would still increase by $39. 2 billion,
which would be 10% or $653 for an average American family.
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Also, the proposed tax relief is small in comparison with tax relief
provided in the past for the same purpose.
than twice as large in today's economy.
The tax cut of 1963-64 would be more
Yet that tax relief occurred at the same
time inter:~l following a business recession and for the exact same purpose.
Also, the tax relief of 1975 would be larger in today's economy (see Chart 1).
CHART 1
Tax/GNP
PAST TAX CUTS SIZED FOR THE FY 79 GNP
$51 B.
50 B.
2.2'1,
$32 B.
!'lo
1963-64
JOHNSON
1.4'1,
$24 B.
1975
FORD
1979
CARTER
25 B.
The Administration's proposed tax relief is small for business, only
$5 .1 billion or one-fifth of the total tax relief.
earmarked for business tax relief in two decades.
This is the smallest proportion
The Kennedy-Johnson
Administration provided one-third of the 1963-64 tax relief for business (see
Chart 2).
CHART 2
PAST TAX RELIEF FOR BUSINESS
SIZED FOR THE FY. 19 79 GNP
Tax/GNP
20 B
1.0%
$18 B.
0.8%
10 B
0.5%
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$7 B.
0.3
1963-64
JOHNSON
1975
FORD
$5 B.
0.2%
1979
CARTER
206
The Administration's proposed tax relief to directly stimulate investment
is particularly anemic.
The direct stimulus for investment is much smaller than
has occurred in the past (see Chart 3).
CHART 3
PAST TAX RELIEF FOR DIRECT INVESTMENT
SIZED FOR THE FY 1979 GNP
Tax/GNP
10 Billion
$9 B.
0.4%
0.4%
5 Billion
$5 B.
0.2%
I
1963-64
JOHNSON
0.2%
I
$2 B.
I
1975
FORD
0.1%
7
1979
CARTER
The need for stimulating investment is greater today than at any other time during
the last two decades.
The decline in the growth of investment in plant and
equipment has led to less modem equipment for each worker and thus less output per
man hour, or productivity (see Table 5).
TABLE 5
GROWTH IN INVESTMENT IN PLANT AND EQUIPMENT
AND PRODUCTIVITY
Capital per
Labor Hour
Productivity
Growth
3.4%
3.1%
3.3%
3.0%
2. 8%
2.1%
-o. 2%
1.7%
1.3%
Investment Growth After
Adjusting for Inflation
1948 - 1966
1966 - 1973
1973 - 1978 I
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The slow pace of business fixed investment can also be shown in
relationship to the recovery from the 1975 recession in contrast to other economic
recoveries (see Graph 1),
GRAPH l
REAL BUSINESS FIXED INVESTMENT
OURlNG BUSINESS CYCLES
l 1973: ◄ = 1 .Q J
CURRENT CYCLE \GNP PERK =157'3: ◄ J
AVE, 4 PREVIOUS CYCLES ll95 ◄ ,19fi8,i!ltil,l!J70J
i .210
I
I _,,,
1.110
,!-------··'
I
~ ! ,C!IO
!
74
Source:
,
"
?!I
77
:IIJAR:'Ell:LT llArA
?II
"
,',
National Chamber Forecasting Center
Investment is officially discouraged by the Federal government.
For
example, according to Chamber analysis, legislation proposed by the President,
enacted by the Congress and signed into law by the President will reduce
investment for each new worker by $950 by 1979, $2,000 by 1980 and $3,750 by
1985, below what it would ha:ve been without the legislation.
If legislation
pending at the end of 1977 which the President proposed were included, then the
loss of tools for each worker would be $2,150 by 1979, $5,200 by 1980 and
$11,350 by 1985 compared with conditions otherwise (see Table 6).
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TABLE 6
Impact on Investment
For Each New Worker
LEGISLATION ENACTED DURING 19 77
1978
Economic Stimulus
Minimum Wage
Social Security Taxes
Farm Price Supports
Federal Pay Increase
1979
1980
1985
1,450
850
350
250
-150
-2,350
-2 ,600
-2 ,400
0
-200
-600
-2, 750
-150
-250
-200
-250
-50
-100
-100
-100
1,050
-2,050
-3 ,200
-5 ,250
550
-950
-2,000
-3, 750
Energy Taxes
-550
-1,800
-3,350
-7 ,100
Regulation of Intrastate Natural Gas
-600
-800
-1,150
-2 ,350
Gross Impact
Net Impact (remove overlapping
policy effects)
PENDING LEGISLATION
Labor Law Reform
Gross Impact of Enacted and Pending
Legislation
Net Impact of Enacted and Pending
Legislation (remove overlapping
policy effects)
0
-100
-550
-3,600
-100
-4,500
-8,300
-18, 450
-50
-2,150
-5,200
-11,350
This undermining of workers' productivity and their real income may be
rem·edied by more tax relief to encourage investment.
According to the Chamber's
econometric analysis, first priority to encourage investment in the near term
should be an increase in the Investment Tax Credit; the second priority should be
a reduction in the capital gains tax; the third priority should be a more adequate
depreciation allowance; and the fourth priority should
reduction.
ge
a corporate rate
Tax relief for encouraging investment would greatly expand investment
(see Table 7).
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Federal Reserve Bank of St. Louis
209
TABLE 7
INVESTMENT BY 1982 FROM $1 BILLION TAX RELIEF '!'HIS TI:AR
FOR
CORPORATE
RATE REDUCTION
LIBERALIZED
DEPRECIATION
$0. 7 billion
$1. 7 billion
LARGER INVESTMENT
TAX CREDIT
LIBERALIZED
CAPITAL GAINS TAX
$2.2 billion
$2.0 billion*
*Based on a conservative estimate of the tax change effect on the stock market.
further analysis, this estimate may adjust upward, not downward.
With
The latest Chamber-Gallup Business Confidence Survey reinforces the conclusion
that business would increase investment with tax relief.
One half of a cross-section
of American business' said they would invest more with tax relief designed to
encourage investment.
MONETARY POLICY
During the next 12 months, assuming a continuation of present monetary policy,
the Chamber forecasts money supply M-1, to increase between
S½ to 6½%, M-2 to
increase 8½-9½% and M-3 to increase 9½-10½%; non-borrowed reserves to increase 5-5½%;
federal funds rate to initially peak at 7½% and then decline by year-end during 1979.
If federal spending is held to the $38 billion increase level proposed by the
President in January, monetary policy need not cause a harmful outflow of savings
from thrift institutions (disintermediation) or a credit crunch.
The President's
March increase in spending of $8 billion and the Congressional Concurrent Resolution,
however, add
to the risk of a credit crunch, a marked slowdown in housing starts
and a recession.
If spending can be controlled and t:he planned deficit reduced,
then the United States can experience a healthy economy through 197~, 4nd even
beyond.
28-083 0 - 78 - 15
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Federal Reserve Bank of St. Louis
210
THE UBRARY OF CONGRESS
Congressional Research Service
WASHINGTON, D.C.
20540
FEDERAL RESERVE SYSTEM TARGETS AND MACROECONOMIC MEASURES:
SELECTED DATA SERIES
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Prepared for the Committee on Banking,
Housing and Urban Affairs
United States Senate
by
Roger S. White
Analyst in Money and Banking
Valerie L.
Gregg A.
Economic
Economics
Amerkhail
Esenwein
Analysts
Division
April 19, 1978
211
FEDERAL RESERVE SYSTEM TARGETS AND MACROECONOMIC MEASURES:
SELECTED DATA SERIES
Listing of tables and graphs
I.
Federal Reserve System targets:
Money supply and Federal Reserve System
one-year target ranges, 1975 to date (graphs)
Ml
M2
M3
l
2
3
Federal.Reserve System one-year target rangesand actual growth rates for monetary aggregates,
1975 to date (table)•••••••••••••••••••••••••••••••••••
4
Money supply growth rates and two-month Federal
Open Market Committee target ranges, 1975 to
date (graphs):
Ml
M2
Federal funds rates and Federal Open Market
Committee target ranges, 1975 to date (graph)
II.
5
6
7
Forecasts:
Economic forecasts: for the period first quarter1978 through first quarter 1979 (table)••••••••••••••••
8
Economic ~orecasts: underlying monetary policy
assumptions••••••••••••••••••••••••••••••••••••••••••••
III.
9
Selected economic developments:
Gross national.product in current dollars, 1972
dollars and percent changes, 1973 to date (table)
10
Percentage changes in nominal and real gross national
product, 1973 to date (graph) ••••••••••••••••••••••••••
11
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Federal Reserve Bank of St. Louis
212
CRS - ii
FEDERAL RESERVE SYSTEM TARGETS AND MACROECONOMIC MEASURES (Cont.)
Percentage changes in the implicit price deflator
for gross national product, 1973 to date (graph) ••••••••
12
Summary of price changes, 1973 to date (table)
13
Changes in wholesale and consumer prices, 1968 to
date (table)••••••••••••••••••••••••••••••••••••••••••••
14
Percentage changes in the consumer price index, 1973
to date (graph)•••••••••••••••••••••••••••••••••••••••••
15
Percentage changes in the wholesale price index, 1973
to date (graph) •••••••••••••••••••••••••••••••••••••••••
16
Selected unemployment rates, 1973 to date
(graphs and tables) •••••••••••••••••••••••••••••••••••••
17
Industrial production and capacity utilization, 1973
to date (graphs and tables) •••••••••••••••••••••••••••••
18
Capacity utilization for materials industries, 1973
IV.
to date (table)•••••••••••••••••••••••••••••••••••••••••
19
Gross private domestic investment, 1973 to date
(graphs and tables) •••••••••••••••••••••••••••••••••••••
21
Disposition of personal income, 1969 to date
(graphs and tables) •••••••••••••••••••••••••••••••••••••
22
New construction, new private housing and vacancy
rates, 1969 to date (tables) ••••••••••••••••••••••••••••
23
Balance of payments on current account and on
merchandise trade, 1973-1977 (graph) ••••••••••••••••••••
24
Financial sector:
Income velocity of-money (Ml), 1973 to date (graph) •••••
25
Selected interest rates, 1973 to date (graph) •••••••••••
26
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Federal Reserve Bank of St. Louis
213
CRS - 1
MONEY SUPPLV AND FEDERAL
RESERVE TARGET RANGES
(Quarterly Data)
$ Billion
380.-----------------.
MONEY SUPPLY (MU
360
340
320
300
Actual Money Supply (Ml):
currency and demand deposits
280
0 '--.____,____._..___.____.___............._..............__.__-'--'-___._~.......__.. . . . .
10 2
3 4 10 2 3 4 10 2
3 4 10 2
3 4 10 2
3 4
'-1975_/ '-1976_/ '-1977_/ '-1978_/ '-1979_/
Note: The target range for 1st quarter 1976 was set for average Ml for March 1976. Actual Ml shown
above is for the entire 1st quarter 1976 to provide consistency with other M1 observations.
Data Source: Quarterly observations and target levels calculated from seasonally adjusted money supply
series of the Board of Governors of the Federal Reserve System as r_evised in March 197_8.
Prepared by Congressional Research Service, Library of Congress.
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Federal Reserve Bank of St. Louis
214
CRS - 2
MONEY SUPPLY AND FEDERAL
RESERVE TARGET RANGES
(Quarterly Data)
$ Billion
900.---------------t
MONEY SUPPLY (M2)
850
800
750
700
650
Actual Money Supply (M2): currency,
demand deposits and consumer type time
and savings deposits at commercial banks
0 ....__.__.__.___.___.__..._......._....._.....__....__....__..__.__.___.___.__..___.__,
10 2
3 4 10 2 3
4 10 2
3
4 10 2
3
4 10 2
3
4
'-1975J '-1976_/ '-1977J '-1978_/ '-1979_/
Note: The target range for 1st quarter 1976was set for average M2 lor March 1976. Actual M2 shown
above is for the entire 1st quarter 1976 to provide consistency with other M2 observations.
Data Source: Quarterly observations and target levels calculated from seasonally adjusted money supply
series of the Board of Governors of the Federal Reserve System as rul'ised in March 1978.
Prepared by Congressional Research Sefvice. Library of Congress.
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Federal Reserve Bank of St. Louis
215
CRS - 3
MONEY SUPPLY AND FEDERAL
RESERVE TARGET RANGES
(Quarterly Data)
$ Billion
1500
l
,,
.
,
,,
,,,,,,
,,,'
MONEY SUPPLY (M3)
1400
,
,;<.,.'\
,,,~
1300
" ,
~ ,
1200
1100
Upper and Lower
Federal Reserve Targets
,,,'
,,
,,
.,
,,,
Actual Money Supply (M3): currency, demand deposits,
consumer type time and savings deposits at commercial
banks and deposits at t_hrift institutions.
010 2 3 4 10 2 3 4 10 2 3 4 10 2 3 4 10 2 3 4
'-1975J '-1976_/ '-1977../ '-1978_/ '-1979J
Note: The target range for 1st quarter 1976 was set for average MJ lor March 1976. Actual MJ shown
above is for the entire 1st quarter 1976 to provide consistency with other M3 observations~
Data Source: Quarterly observations and target levels calculated from seasonally adjusted money supply
series of the Board of Go!ernors of the Federal Reserve System as revised in March 1978.
Prepared by Congressional Research Service. Library of Congress.
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Federal Reserve Bank of St. Louis
216
CRS - 4
FEDERAL RESERVE SYSTEM ONE YEAR TARGET RANGES AND ACTUAL
GROWTH RATES FOR MONETARY AGGREGATES
(Growth rates in percent)
Ml
M2
Actual
1. March 1975 to March 1976
5.0 - 7.5
5.0
8.5 - 10.5
2. 1975:Q2 to 1976 :Q2
5.0 - 7.5
5.2
8,5 - 10.5
5.0 - 7.5
4.5
7 .5 - 10.5
9.3
4.5 - 7.5
5.7
7.5 - 10.5
10.9
3. 1975:Q3 to 1976:Q3
4. 1975:Q4 to 1976:Q4
5. 1976:Ql to 1977 :Ql
6. 1976:Q2 to 1977:Q2
7. 1976:QJ to 1977 :Q3
8. 1976 :Q4 to 1977:Q4
9. 1977:Ql to 1978:Ql
10. 1977 :Q2 to 1978:Q2
11. 1977 :Q3 to 1978:Q3
12. 1977:Q4 to 1978:Q4
....
..........
..........
..........
..........
..........
..........
..........
··········
··········
··········
··········
Target
M3
Target
Period covered
Actual
Target
Actual
9.5
10.IJ - 12.0
12.3
9.5
10.0 - 12.0
12.0
9.0 - 12.0
11.5
9.0 - 12.0
12.8
4.5 - 7.0
6.3
7.5 - 10.0
10.9
9.0 - 12.0
12.8
4.5 - 7,0
6.6
7.5 -
9.5
10,7
9.0 - 11.0
12.4
4.5 - 6,5
7.8
7.5 - 10.0
11.0
9.0 - 11.5
12. 7
4.5 - 6.5
1.a
7.0 - 10.0
9.J
8.3 - 11.5
11.7
4.5 - 6.5
7.3
7.0 -
8,6
8.5 - 11.0
10.4
4.0 - 6.5
NA
7.0 - 9.5
NA
8.5 - 11.0
NA
4.0 - 6.5
NA
6.5 - 9.0
NA
8.0 - 10.5
NA
4.0 - 6.5
NA
6.5 - 9.0
NA
7.5 - 10.0
NA
9.5
Ml• private demand deposits plus currency.
0
M2 • Ml plus bank time and savings deposits other than large negotiable CD'•
M3 • M2 plus.deposits at mutual savings banks, savings and loan associations and credit
unions
NA• not applicable.
IIO'rE: · Actual growth rate data arc based on money supply series of the Board of Governors
of the Federal Reser~e System as revised in March 1978.
Prepa.r:?d by ron~rcss i.ona.l Re,earch Service, Library of Congress
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Federal Reserve Bank of St. Louis
MONEY SUPPLY (M1) GROWTH RATES AND TWO MONTH
FEDERAL OPEN MARKET COMMITTEE TARGET RANGES
14
Actual growth rates
12
-;:;
C:
"\..
10
CIJ
...u
CIJ
..9-
8
...E
...~
6
Cl
4
Ill
CIJ
~
e
iii
:,
C:
C:
<I:
2
Two
months
ending
with -
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
....__.............._....,._
J
f
M ,, M
J
J
A
S O N
I
D
J
F
M A M
I
J
J
A
S D
I
N D
J
F
M A M
I
J
J A S O N
D
J
F
M A
'-----1975---- '-----1976---- -----:,1977---..J'--1978
SOURCE: Tim.1ut ranges are from Federal Open Marht Committet Records of Policy Actions. Actual growth rates are
cah.·,lated from money wpply series of the Board of Governors of the Federal Reserve System asof March 1978.
Pre1.:&red by the Congressional Research Service, Library of Congress.
MONEY SUPPLY (M2) GROWTH RATES AND TWO MONTII
FEDERAL OPEN MARKET COMMITTEE TARGET RANGES
16
- ~ Actual growth rates
14
2
Two
months
ending
O ...._..__,___.____._...._.._....._.....____.___._...._....___,___,____._...._.._....._.....____.___._...._....__....._____.__.~...._....__.....___,____._...._..__,__.....____.__....._~..........
with -
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
J
F
M A
M
J
J
A
S
O N
D
J
F M A
M
J
J
A
S
O
N
D
J
F
M A
M
J
J
A
S O N
D
J
F
M
A
----1975------ -------1976----.J '-----19n----''---1978
SOURCE: Target ranges are from Federal Open Market Committee Records of Policy Actions. Actual growth rates are
calculated from money supply serlts of the Board of Governors of the Federal Reserve System as of March 1978.
Prepared by the Congressional Research Service, Library of Congress.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
FEDERAL FUNDS RATES AND FEDERAL OPEN
MARKET COMMITTEE TARGETS
.
6.0
C
0
l:!
QI
(/)
~
QI
1:-.:)
Q,.
-..J
4.0
JFMAMJJASONDJFMAMJJASONDJFMAMJJASONDJFMA
\__1915 __;_/ ~1976 ___/ \ _ _ 19n ___/ \_191s
SOURCE: Target ranges are from Federal Open Mars.et Committee Records of Policy Actions. Weekly averages of f~eral
funds rates are from the Board of Go\lernors of the Feder di Reserve System data series, accessed from data files
of Data A~$0urces, Inc.
Prepared by Congressional Research Servi~. Libfary of Congress.
.....
<:O
220
CRS - 8
ECONOMIC FORECASTS:
FOR THE PERIOD FIRST QUARTER 1978
THROUGH FIRST QUARTER 1979
DRI
Real Growth
(% change in
constant$ GNP)
3.5
4.4
5.6
?
Inflation
(% change in
GNP Implicit Deflator)
6.3
6.1
6.3
?
Percent change in
civilian labor force
1.8
1.8
2.3
?
Unemployment rate:
average during
entire period
first quarter 1979
6.0
5.8
6.1
6.0
6.1
5.8
?
?
Percent change in Federal
Reserve industrial
Production Index
5.9
6.2
6.7
?
Growt;h of money supply (Ml)
(percent)
6.9
5.4
6.2
?
Federal funds rate
first quarter 1979
6.09
6.52
7.91
?
SOURCES:
Wharton
Federal
Reserve
Chase
Chase Econometrics: Interim Forecast of April 3, 1978.
Data Resources (DRI): Control Forecast of March 23, 1978.
Wharton EFA: Quarterly Model Control Solution Update of
April 4, 1978.
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Federal Reserve Bank of St. Louis
221
CRS - 9
ECONOMIC FORECASTS:
UNDERLYING MONETARY POLICY ASSUMPTIONS
Chase:
"Given the stability in Ml for February and thus far in
March, the monetary aggregates will register a welcome
slowdown in the first quarter. We t~en expect a gradual
strengthening in money growth over the remainder of the-year with Ml and M2 expanding at 6 1/2% and 9% rates in
the remaining three quarters of 1978. Thrift institution
deposits are also expected to revive later in the year,
with increases projected at a 10% rate over this period."
--Chase Econometric Associates, Inc.
casts, March 1975, p, 43.
DRI:
Macroeconomic Fore-
''Monetary policy is tightened another notch in the late
spring in response to rapid monetary growth, international
currency difficulties, and accelerating inflation. The
Fed eases policy somewhat during 1978:3 to 1979:2 as economic growth slows and unemployment remains far too high
relative to Administration goals."
--Data Resources Review, April 1978, p. II.7.
Wharton:
Assumptions include an increase of 5.9% in nonborrowed
reserves from the first quarter of 1978 to the first quarter
of 1979, and an increase in the rediscount rate from 6.5%
to 7.5% between the second and third quarter of 1978.
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Federal Reserve Bank of St. Louis
222
CRS - 10
GROSS NATIONAL PRODUCT, IN CURRENT DOLLARS,
1972 DOLLARS AND PERCENT CHANGES
GNP
billions
of current
dollars 1/
Period
1973
1974
1975
1976
1977
% change
GNP in
current
dollars 2/
GNP
% change
of 1972
dollars
GNP in
1972
doilars 2
billions
1,306.6
1,412.9
1,528.8
1,706.5
1,889.6
11.6
8.1
8.2
11.6
10.7
1,235.0
1,217.8
1,202.1
1,274.7
1,337.3
5.5
-1.4
-1.3
6.0
4.9
1976:
I
II
III
IV
1,651.2
1,691.9
1,727.3
1,755.4
13.2
10.2
8.6
6.7
1,256 .o
1,271.5
1,283.7
1,287.4
8.8
5.1
3.9
1.2
1977:
I
II
III
IV
1,810.8
1,869.9
1,915.9
1,961.8
13.2
13.7
10.2
9.9
1,311.0
1,330.7
1,347.4
1,360.2
7.5
6.2
5.1
3.8
1,992.9
6.5
1,358.3
-0.6
1978:
Ip
p • preliminary.
}_/
Quarterly data at seasonally adjusted rates.
];/
Annual changes from previous year and quarterly changes from previous
quarter, at seasonally adjusted annual rates.
SOURCE:
Department of Commerce, Bureau of Economic Analysis.
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
18
20
18
16
16
14
12
10
8
6
4
14
12
10
8
6
4
2
0
20
...
Z'
l&,I
u
Qt
l&,I
Q.
PERCENT'CHANGE IN GROSS NATIONAL PRODUCT lGNP).
QUARTERLY lSEASONALLV ADJUSTED ANNUAL RATES)
CURRENT DOLLAR GNP CLINE>
CONSTANT DOLLAR GNP (DOT)
2
0
-2
-4
-6
-8
-10
.. . .,....
. .... ••....
.••
I
I
•
•
I
I
I
I
....-· -,'.
..
''.
..... •.•
.• ...•
'.
'...
•
''
'
I
I
.
I I
.....
\
I
I
.•.
I
I
.
•
I
,.-,.
-2
I
I
I
-4
-6
-8
-10
I
I
1973
1974
1975
1976
19~
1978
41'191'78
Data source: Department of·Com.~erce, Bureau
of Economic Analysis.
Prepared by Congressional Research Service, Library of Congress
0
!J:I
(/.l
~
~
t,:)
t,:)
i:,:i
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
15
14
PERCENT CHANGES IN THE I"PLICIT PRICE DEFLRTOR.
FOR GROSS NATIONAL PRODUCT. QURRTERLV
(SEASONALLY ADJUSTED ANNUAL RATES)
- - - --------,,- U5
14
13
12
11
10
13
12
11
10
...z
9
9
&&J
8
Ole
7
8
7
6
6
5
4
5
4
3
3
u
&&J
D.
2
2
1
1
0
0
1973
1974
1975
1976
1977
1978
4.1191'78
Data source: Department of Commerce, Bureau
of Economiq Analysis.
Prepared by Congressional Research Service, Li9rary of Congress
(")
~
[/)
I
~
I\)
~
~
H'>,.
225
CRS - 13
SUMMARY OF PRICE CHANGES
[Percent change from previous period;
quarterly data at seasonally adjusted
annual rates]
GNP implicit price
deflator 1/
Period
Consumer price Wholesale price
index 2/
index 2/
1973
1974
1975
1976
1977
5.8
9.7
9.6
5.3
5.5
6.2
11.0
9.1
5.8
6.5
13.1
18.9
9.2
4.6
6.1
1976: I
II
III
IV
4.1
4.9
4.6
5.4
5.2
4.9
5.7
4.3
1.1
5.4
4.5
4.9
1977: I
II
III
IV
5.3
7.1
4.8
5.8
8.4
8.8
5.3
4.3
9.0
9.3
.3
5.8
1978: I p
7.1
NA
9.8
1,/
·Department of Commerce, Bureau of Economic Analysis.
!/
Department of Labor, Bureau of Labor Statistics.
]./
p
~
preliminary.
28-083 0 • 78 • 16
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Federal Reserve Bank of St. Louis
226
CRS -
14
CHANGES IN WHOLESALE PRICES
\I
Percent change from prtteding
period; seo.sono.lly adjusted 1
Period
Fann
proddcts
All
com:-
1969 ••••••• 1
4.
81
7. 5
modit'
Jes
I
3,
0
I
I prodi;ts
F•nn
All
I
com:-
goods I m~d1ties
I
11
4.
8
~~ ' ~~
2. 2
2. 2
0
=~ g
i~h~.~I -: f
Aug..
Sept..
-1. 2
- ..5
.9
23
:
I. I
2. 5 ,
31
i
1!1
•7 .
, 7 :1
• 5 \l
:~
f
• 511
•6 1
• 5 :I
.3
5 :
•7 I
.7 1
.
i
Indus•
twi.l i'ji Fincom- , ished
goods
modi-1
Percent change Crom 6 months
earlier; sensonally adjusted
annual rates
I com:-
1 .......
AU
'1
I
F>rm
produdcts
an
modi- , processed
tic!
foodit and
feeds
II Industru:1.l
Finiahed
oods
com-
I
•······il·······
modit·
ies
g
11·······1····•···•· 1
:
:
:
t
:
~
~
···;.-~r····;.-~·1···;,·~· ····;.-~
1:1:::1::i:1:1::i:i111l::i::111:::::1~1:::::::1
1
I. I
1. 0
•4
'1
an
proc~scd
foods :ind I tie
feeds
(
s
l..••...... l.......
11 . . . . . . .
i :!1:m::::
::;;;·i~~~:, !: :
•1
•3
(~ct...
•6
:-.ov• • • 7
Dec..
•4
1078: Jon..
.9
Feb •• l 1. O
I
Fin-
com-1 ished
proce85ed
foods :ind
feeds
1m::::i i :! 1
Mar··.
Apr..
~bv.'
Industrial
an
I
m?d1ties
I
Percent change from 3 montha
earlier; sea.c;onn.lly ndjusted
annual rates
.I
~:
~ i1•··~.·J····;;:~r·;:~· 1··;~,·~·'
1 I. I I
13. 6 ,
JO, 51
. 8 i1
. 7 ,i
. 8 j/
I 9. 3
29. 5 :
19. 3 :
:it~ 1 t i ,
~O,
J 'i
. 32 i
-1. 2 1·
1. 9 ,
. 6 i' 4. 2
.nil o.s 1
. 5 i:
G. 91
• 6 ,, 8. 0
1. I I1 9. 4 i
•
1
8, 8
9. 4
8. 0
-2~. 9
-1,"l. 0
-3. 4
10.s
14. 7
15. 8
16, 6
I
IAonu:\l chan~H nrt !to'Tl Dtcerobcr 10 Dtrt'11·I tr (unadJufttd).
911
S.
7. 0
G. 3
5.2,
4. 7 'I
6. 0
7. 8 !
10. 0
10. 5
9, 4
8. 51
Jo. 1
9. 9
u ~:
4. 5
2. 0
2. D
2. 9
I
4. 7
,6,3,
7. O
7. 2 1
9. 2
2, I
2.6
4. 4
6. I
8. 0
I
II. 8 1
19. 0 ,
18. 6
~~
-4. I
-9. 2
-11. 6
-7.6
-1.,3·
5. 8
13. 7
II
I
I
,
:
1
7. 6
8. (
7. 7
7. 5
9. 2
Jo. 0
~:;
~~
6. 9
6. 7
6. I
5.5
5. 8
6. 1
G. 5
5. 6
4. 7
4. 5
4.1
4. 9
5. 9
7. 7
I
Sourct: Dcpartmt"nl of Labor, Bureau of Labor Statistics.
NOTE.-D().l:l revlfrd for AUl,"Uft 19;7.
CHANGES IN CONSUMER PRICES
Percent change from nreceding
period; sensonnlly ru.ljustC'd 1
Pe1iod
All
items
:~n::::::::i
mL:::::I
1973 .••••••• I
1974
..•••••• 1
1975________
1
19ifi ________ t
1977
i
I
l
Food
1l. 8
•8
•6
•5
•6
•6
~cpt
Oct_•••
__ f
•4
•3
Nov•••
Dee ___ ,
•4
.4
1978: Jn.u •• _/
Feb ___
•8
•6
1. 2
~
I
Serv
All
ices - \ items
I I ~~=
i ~= I I I I ~':,d: I
Ser••
ices
Food
All
items
Food
food
1
lu~~::1
July ••• !
Aug ___
Af,'···1
1
1
food
i1~::
food
SerV•
ices
,ff il ~ r ,m:t:~: 1: : :i;1~:: :~!:~~:i~ ~:~~~1:i:~:~1~t: : :'i:~: i:
8. 0
2.1
•6
1. 5
10;1~F~~:::1
l\:Iar ___ /
I! ~':,d:
i::: I
!'Percent ehnna:e from 3 months earlier ,,Percent chnnge from G months e:.rlier;
~a,;on:llly n<lju~tcd annual r.Mes 1 se~ona.lly adjusted nnnun.l rates
1. 0
•6
•3
•4
•4
.,• 2
-.2
•2
•5
I. 3
1
~
D
•6
.(
•4
•3
•3
.2
•2
•6
•8
•7
•R
•7
•7
•6
•5
•5
•6
•4
.4
•4
'71
.2
•6
•7
.• 3
(
I
7 9 '
9.
10.
10.
8.
7.
5.
5,
4.
4.
4.
4.
1
0
2
4
8
7
0
5
5
;
13. 7 I
15. 3
18. 6
II. 6
II. 5
4. 2
3. 6
I. 9
3.1
6.1
4. 8
4. 2
3,2,
4. 9
4. 8
4. 7
10. 6
12. G
13. 4
11. 2
7. 5
6. 6
3, 7
3, 6
3, 0
5. 8
7. 2
5. G
6. 1
6. 0
7. 7
9. 0
9. 9
9. 4
9. 3
2. 71
2. 7
8. 3
7. 6
6. 3
5. G
7
9
3, 5
4. 2
3.41
4. 7
5. (
G. 7
7.5
8. 9
11. 9
5. 6 I
1Annual ch4Dll!S ue 1rom December to December (WiadJust.d).
a. u I
8. 0
8. 7
8.9
7. 9
6. 6
6.1
5.1
Source: Department of Lt.bor, DUJ'eaa of Let.or St:irtaUe4,.
Note.-B,i::lnnlni: January 1!178 dat11 rtlale to all urban consumcn. Eartlcr data
·
h~t• to urb3n w111c earners and cltrkal workers.
Reproduced rroa Bconoa1c Ind1cator1, March 1978.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
••••••••••••••••••••••••••••••••••••••••••••
6. 8
7. 7
7. 6
6. 6
6. 5
6. 6
7. I
7. 4
9. 8
7. 7
6. 5
7. 4
5
2
8
6
7
5
3
7
0
s. 0
8. 7
9. 6
9. 2
9. 1
8. 5
7. 8
7. 0
G. 3
5. 0
6. 0
a.,
6.
6.
5.
4.
3,
3.
3,
3,
4.
5. 1
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
16
PERCENT CHANGE IN THE CONSUMER PRICE INDEX
(QUARTERLY CHANGES.SEASONALLY ADJUSTED ANtlURL RATES>
14
12
10
I-
z
u
LU
°'
&LI
a..
8
6
4
2
0
1973
Data source:
1974
1975
1976·
1977
1978
Department of Labor, Bureau of Labor'Statistics4 ✓17✓78
Prepared by Congressional Research Service, Library of Congress
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
35
PERCENT CHANGE IN THE HtfOLESALE PRICE IHOEX
(QUARTERLY CHANGES.SEASONALLY ADJUSTED ANHUAL RATES)
30
25
~
I
0
00
~
e
IS
....
:z:
w
u
~
20
15
UJ
0..
10
5
0
-s
1973
Data source:
1974
1975
1976
1977
Department of Labor, Bureau of Labor
1978
Stattstics4 ✓ 17✓78
Prepared by Congressional Research Service, Library of Congress
229
CRS - 17
SELECTED UNEMPLOYMENT RATES
The s•asanally adjusted unemp.layment rate declined in Fel:-.ruary by 0.2 percentage point to 6.1 percent. Only the
unemployment role for teenagers increased.
ftRCENT• !SEASONALLY ADJUSTED)
PERCENT'- ISEASONAlLY ADJUSTED)
201----------------~
,,
I
•
I
~r'
/~
15
0
.......
1974
I.
1975
••-o,MUn ..,, 1•uc&1r o, (l'fU,O,N ~ tollUI '" GIIOUI' UUlfllQ,
aou.c.t.w...,,...,.,o,v.aoa
(l\fonthly datn ~casonatly ndjusted]
Uncrnployn1ent rnte (percent of civili;in labor force in group)
Total
(all
Period
civilian
workers)
1973 •••••••• ·- -- -- ---- -- ----'
mt
l'eb. __________________
l\'Iar ___________________
l
May
A.pr--------------___________________
-- --
June._. _______________
1!178:
ri)~~~~~~~~~~~~~~~
i~b: ::::::::::::::::::!
4. 9
5. 6
s. 5
7. 7
7. 0
7. 6
7. 4
7. l
7. I
7. 1
6. 9
7. 0
6. 8
6. 8
6. 7
6. 4
6. 3
6. 1
By sex and n.ge
By race
i
I Black
1
Men ! \Vomen
1
,
20 1 20
Both
.
I
--·1~ -1
~-n~•-1-1=•=
·-·~~~~,~~
I
over
3.21
3. 8
6. 7
5. 9
5. 2
5. 0
5. 6
5. 2
fi. 3
5.1
5.1
5.1
4. 7
6. 0
4. 7
4. 6
4. 7
4. 5
over
yeo.ra
4. 8
5. 5
14. 5
16. ()
8. 0
10. 9
7.4
7. 0
7. 2
7. 2
7. 0
6. 9
7. 2
6. 9
7.1
6. ~
6. 8
6. 9
6. 6
19. 0
17. 7
18. 6
18. 7
18. 2
IS.I
18. 0
17. 3
17. ~
18. 3
17. 3
17. 2
15. G
16. 0
17. 4
6.11
5. 7
'r1enced' House-
1\:!!k7rs:
4.3i
5.
0
7. S
7. 0
6. 2
6. 8
6. 6
6..
6,.3
6. 3
6.1
6.1
6. 0
6. 0
5. 0
5. 5
5. 5
5. 3
I
s. 9 I
9. 0
13. n
13. l
13.l I
I
13. l
12. 0
12. 3
12. 9
13. 2
13. 3
14. 3
13. I
13. 7
J:l.7
12. 7
12. 7
11.8
gj
8. 2
7. 3
6. 6
7. l
6. 0
6. 0
6. 7
6. 5
6. 4
6. 5
6. 3
6. 5
6. 3
6.0
5. 9
5. 7
I
~ult-
i
era
2. 9
3. 3
5. 8
5. l
4. 5
4. 0
4. 7
4. 5
4. 5
4. 3
4.4
4.5
4. 4
4. 4
4. 2
3. 9
3. 8
3. 6
4. 3
5.1
l!.I
7. 3
6. 5
6.0
6. 8
6. 6
6. 6
6. 5
6.fi
6. 6
6. 4
6. 4
6. 2 I
5. 80
5.
5. 7
Reproduced troa Econoaic Indicators, Maroh 1978.
P~rt--
time
lost
(per-
cent)
1
ere
I
Sourct": DepartmonC of Lol,or, Dureau of Labor StatistJCL
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
\ Labor
force
By selected groups
I ~xpe- !
7. 9
s. 6
10. 3
10. l
o. 8
10. 6
lo. 9
9. 9
9. 9
10. 5
9. 3
9.0
9. 7
9.6
9. 6
s. 9
8. g
8. 6
5. 2
6. 1
9. 1
8. 3
7. 6
s. 0
7. 8
7. 4
7. 6
7. 6
7••
7. 6
7. 4
7. 4
7. 3
7. 0
6. 8
6.6
,
230
CRS -
18
INDUSTRIAL PRODUCTION AND CAPACITY UTILIZATION
Industrial production rose 0.5 percent in February following an 0.8 percent decline in January.
N>IX, 1967•100• {RA'TTOSCAU)
INDllt, 1967• 100• IRA110 SCAU1
160
180
TOTAL INDUSTRIAL PRODUCTION
UTILITIES AND MINING PRODUCTION
1974
I
Period
Total industrial I
production
I
Index,
1967=
100
~ft'.::::::::
197S: Jan•-------·
Feb•-------
138. 51
139. 2
Mnnufncturi~~--
Percent
chnn~c
from
Total
Y<'lll'
earlier
1967 proportion ___ . 100.00
1972.
-- ---------- 119. 7
1973 _____________
1974 _____________ 129. 8
1975 _____________ 129. 3
1976 _____________ 117. 8
129. 8
1977 _____________ 137.
0
1977: Feb ________ 133. 2
l\,Iar ________ 135. 3
Apr ________
I
May ________ 136.
137. 0
June. _______ 137. 8
July ________
138. 7
Aug ________
138. I
138. 5
138. 9
Nov.,. _______ 139. 3
Dec ________ 139. 6
(Sea.11ona1Jy adjusted}
Industry production indexes, 1067= 100
-------9. 2
-87.-96-
I
Durable
I
I
Nondurable
6. 36
6.69
139. 4
145. 3
147. 0
147. 0
148. 5
148. 4
148. 6
149. 4
140.5
149. 6
150. I
150. 6
116. 3
120. 6
119. 2
119.S
122. 8
119. 8
115. 4
us. 0
119. 6
118. S
113. 3
149. 7
150.1
113. 3
114. I
36. 97
113.
127.
125.
109.
121.
129.
126.
133.
134.
126.
140.
148.
6.1
5. 2
6. 0
f, 7
5. 9
5. 0
132. 6
135. 1
135. 8
137. 1
137. 8
138. 5
138. 6
139. 0
139. 4
139. 9
140. 5
124. 0
126. 8
128. 0
129. 3
130. 5
131. 6
131. 3
131. 7
132. 4
132. 7
133. 6
4. 7
4. 5
136. 9
139. 7
131. 5
132. 4
4. 4
5. 5
5.7
5. 6
(i. 2
7
I
7
3
7
5
5
8
6
4
9
I
Reproduced Crom Econo111c Ind1cator1, March 19'78.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Utilities
113. I
114. 7
115. 3
112. 8
114. 2 '
117. 8
61. 98
118. 9
129. 8
129. 4
116. 3
120. 5
137. 1
s. 4
-.4
-8.9
10. 2
5. 5
Mining
Manulncturing capacity uUlizat.ion
rate, percent a
Federal Reserve
aeries
I
rials
2-L_/__ ______
Total
manufactur-
Mate-
88. 0
Commerce
series I
I Wharton
I
aeriea a
________ I ________
83
86
83
77
81
83
91.
97.
93.
80.
87.
90.
8
1
0
4
5
156. 4
83.
87.
84.
73.
80.
82.
I
5
2
6
2
4
92.
87.
73.
80.
81.
4
7
6
4
9
100. 3
154. 8
154. 0
156. 7
156. 8
IOI. 4
155. 7
154. 1
154. 0
154. 2
155. 7
80.
82.
82.
82.
83.
83.
82.
82.
82.
82.
83.
9
1
3
8
0
I
9
9
9
9
0
80.
81.
82.
82.
63.
82.
82.
82.
82.
82.
81.
2
6 _____ 83_1_ ___ 8s. 4
I
7
0
90. 4
9
0
0
4
3
8
157. I
157. 3
81. 8
82. 0
145. 4
143. 7
146. 0
151. 0
81.0
80. 9
2
-----'-------_____--84_1__
__
:::::=L:=:
231
CRS - 19
CAPACITT UTILIZATION RATES FOR MATERIALS INDUSTRIES
(In Percent)
Year
Ql
Q2
Q4
Q3
Materials, total
1973
1974
1975
1976
1977
1978
92 .1
90.5
71 .5
79.0
80.4
81.4
92.6
89.6
70.6
80.6
82.6
92.9
89.1
74.8
81.2
82.8
92.1
81. 7
76.9
80.3
82.2
!/
Durable goods mat!rials
1973
1974
1975
1976
1977
1978
90.7
88.5
66.9
73.5
76.5
79.3
91.7
87.4
64.4
76.2
79 .3
92.3
87.7
68.8
78.4
79.6
91.3
79.9
70.3
76.5
79.7
!/
Basic metal materials
1973
1974
1975
1976
1977
1978
97.3
93.9
67.2
77.4
80.2
95.6
94.8
75 .2
72.8
75 .o
na--
97.5
92.0
70.4
81.7
75.3
96.9
86.0
69.9
74.4
75.2
Nondurable goods materials
1973
1974
1975
1976
1977
1978
93.9
94.0
70.0
85.6
85.1
85.9
93.6
93.1
72.5
85.9
87.3
93.4
91.6
79.9
84.8
86.7
93.8
81.5
84.4
84.4
85.9
!/
Textile, paper, and chemical materials
1973
1974
1975
1976
1977
1978
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
94.1
93.7
68.0
85.1
83.8
85.0
93.8
93.3
70.6
85.0
86.3
!/
94.0
92.1
78.5
83.7
85 .1
93.9
81 .2
83.9
83.2
84.5
232
CRS - 20
CAPACITY UTILIZATION RATES FOR MATERIALS INDUSTRIES (Cont.)
(In P~rcent)
Year
Ql
Q2
Q3
Q4
Textile materials
1973
1974
1975
1976
1977
1978
93.0
93.6
60.9
84.3
78.7
NA
93.0
90.4
71.5
83.1
78.1
93.8
85.4
82.7
82.4
78.8
94.6
70 .1
87.0
79.7
82.4
Paper materials
1973
1974
1975
1976
1977
1978
98.4
98.0
78.3
89.1
88.4
NA
99.5
98.4
73.4
90.9
89.4
98.8
97.0
81.2
89.2
89.3
98.2
89.9
86.2
88.1
86.7
Chemical materials
1973
1974
1975
1976
1977
1978
93.2
92.5
67.2
84.2
84.0
NA
92.4
92.7
69.4
84.0
87.9
92.5
92.7
76.5
82.6
85.7
92.4
82.1
82.3
83.0
84.5
Energy materials
1973
1974
1975
1976
1977
1978
]_/
93.8
90.5
86.8
85.3
84.5
80.2 }_/
93.4
90.3
85.1
84.0
84.6
94 .1
89.4
84.3
83.8
85.9
92.0
87.0
84.8
84.8
83.7
Preliminary.
SOURCE:
Board of Governors of the Federal Reserve
System.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
233
CHS - 21
GROSS PRIVATE DOMESTIC INVESTMENT
or
Business fixed investment rose $6.0 billion (annual rate) in the fourth quarter as purchases
producers' durable
equir.mcnt increased $4.1 billion and investment in structure:s rose $1.9 billion. Residential investment increased
$7.2 billion. Inventory investment amounted lo $13.5 billion, down $10.1 billion from the third querier level.
llll!ONS OF DOLLAAS • (RATIO SCALEl
120
_i:,K)NR[SIDENTlAL AXED INV[STMENJ'..
111.UQNS OF OOllARS" !RATIO SCAU)
300 CROSS PRIVATt DOMESTIC INVESTMfNT------""'-"4
......
-·
60 1----+------i----+------i--,,•"'---i
1'0
.,/··r,;··--i:::s:.:··-----·--
f-----+----1---+-----t-----1
•o '-l-'--'--'-1....,__,_..__.,--'....,__,_~~~_,_~..__.,,.
BllllONS OF OOUAII.S {RATIO SCALF,
40
90
OfANGE IN.BUSINfSS INVENTORIES---------,
R£SI0EN11Al FIXED INVESTMENT
50
,m
1976
•SU,SON.lllYAOKJStf::> ANNl:41. lATtS
SQul;;;LCIU'.UIOUHIOft.:,,,••,uu
-
(Billions of dollars; quarterly data at seasonally adjusted annunl rates)
i
Nonresidcntin.l fixed investment
I
l Gross
I private
Period
i
in!~~t-1
ment
I
Producers'
durable
equipment
Structurl'III
domes- ;
Totnl
Totn.l 1 Non-
'i
-------------I
1968
19G• ____________ _
lOil ••• ----------
1072
__ --------- -·
1973 ___________
-1974 ____________ _
1975 ____________ _
rn+~_.-_·::::::::::
197G:
I_ ________ _
""' [>::::::I
120.
131.
146.
140.
8
5
2
8
160. 0
188. 3
220. 0
214. 6
189. 1
243. 3
294. 2
231. 3
244. 4
254.3
243. 4
271. S
20-t 9
303. 6
300. 7
'
Total I Non-
I
: farm
1969 ____________ _1
19i0 ____________ _
82. 1 I 29.5 I 28.2 I 52.6,
30. 4
57. 7
s9. 3 I 31. 6
34.31 63.3
,g~ i I 35.7
36. I
62. 8
37. 7
I
!ft~ i
136. 0
150. n
149, 1
IGI. 9
185. 1
J.'i,'l, 4
15ft S
IG-t. !)
167.
177.
182.
187.
193.
6
0
•I
5
5
!7 f
:~: : I
·
49. 0
4~: 9
54. 5
51. S
52.9
50.4
55. S
53. 4
61. 5
58. 8
.54. 7
52. I
Residential fixed investment
I ;:· 0~
I
87:
96. 2
96.3
JOti. l
123. G
JOO. S
farm
48. 0
53• 4
58. 9
58. I
•9
~iso.i.II
88. 2
87.I
05.9
112. 4
90• 5
.s
~tJ
I U: t :zi: g i~• 4
57. 0 I 54. 4 JIO. 0 100. 7
I:
57. 9 :
61. 0 I
55. I
58. 2
119. 2
121. 4
~ii ~?:~ rnti
1
107. 8
110• 0
0
•8
m·
loarn: Dtpartmeat of Commerct, Dumeu ol F.:ccnomfc Analysis.
Reproduced trom Economic Indicators, Karch 1978.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
j
Chnnge in busiProne.ss inventories
Fn.rm ducers' i
Tc,tnl . farm strncdur- l
1 strucable - - - - - 1
I turcs . tures equipment
Total
NonI
lnrm
I
1•
j
I
I
Non-
I
1
I
I
28. 6
34. 5
37. 9
I
27.
33. 21
I
36. 3
36. 6
49. 6
62. 0
35. I
47. 9
60. 3
66. I
55. I
51. 5
68. 0
91. 0
61. 4
66. 3
67. 8
;o. 7
81. 0
90. 8
92. 5
99. 7
64. 3
52. 7
49. 5
65. 7
88. 4
58. 9
64. I
05. 7
74. 3
78.
88.
89.
97.
5
2
9
1
6
0.• 71
•7
•6
•7
•7
.6
I. 2
•9
1. 0
I. I
I. 2
I. 0
•9
1. I
1. I
1. 2
1. 1
I. 0
0. 7
•8
• 9
.9
I. 0
I. I
I. 2
I. 2
I.I
I. 3
I. 4
1. 2
). 2
1. 2
I. 3
1. 4
I. 4
1. 5
1. 6
10.
7.
9.
3.
6.
I
7
4
S
4
:
!
!
,
'
9. ·l
17. 9
8. 9
-11. 5
13. 3
18. 2
14. 5
JS. 3
21 ..>
-.9
13. 8 I
~UI
ta. s I
9. 4
7. 6
9. 2
3. 7
5. 1
s. 8
14. 7
to. s
-1.;.
14.
17.
15.
20.
22.
I.
1
9
I
9
4
0
4
14. l
22. 4
23. 1
9. 0
234
CRS - 22
DISPOSITION OF PERSONAL INCOME
Rc0I per capita disposable income rose again in the fou,th quarter.
IIWONS
1,-400
a
DOUARS• (RATIO S0J.Q
11.lJONS 01 DOUARS.• (RATIO SCALE)
~.
,.~oo
1,2001-------------------- ----------=::::;;;~:z:::::::::fl::::::~~::-i,.200
~,,:;;:.=
1,000.f-------------------=:;;;;~~=-:5;_;.."""7----+----jl,OOO
DISPOSABLE PfRSONAL INCOME
~ -
~ ------=-:;:j~::::;:a~~--~':"""'=-r-,--,---t--,~
~.
•
. -,, ~ OUTIA~
_J_____J____ j ___ 600
600 _ ~/-
t~.:::s~~-~·"·§·~::~::ir_____'.r::~:r.___
J
""''------'----.._____._____. . ,_________-'----'-----'----.J""'
-----
00UAAS • (RATIO SCAl.f)
DOl.l.AA.S • {P.ATIO SCAU)
IHCOME----------------------:::::a-,....==-! 6,000
s.0001------------------,-------=,.,,.==+----+-----lS.OOO
6,000 1-PfR. CA.PITA OISl'OWLE
PfRSOf.W.
OJRRENTDOI.~
,,ooor-:===~:::==~~;;;;;:,;;;:;::;;;,1==-ee-ee-c,:.•~r:-~----~-•,e•"'
•:e,-:e,•:e,•::•::•+:-:c"c.."_"_-_•_•-1,,000
t- ••••••-,-•••••••. •-1972 DOUARS
3,'000 f---"'-=--+-----+----11----l----+----+----+----1------13.000
• SfA.5Of•U,UY AOJ\ISfl0 »INIJ-'l U.TtS
sou1ct,cu..,,,rM.1:HtOfco-•C1
1
I
1p~~~:
sp0011,••-I 1
Period
Per capita
dispo~11hh•
F.q11al~: ! Liiss:
I son.ii
•t•nxd·
inco~e; non1 tax
! pay-
"!~~s-
p e ~.
50 0 1
Ei~::5:
personal
income
..
lout- I
ays
sonal
saving
i Per capita perI imn:11 consurup-
I
personal income / tion expenditures
I
I
~b~e:et;
in real
P«:r
~~~~:a.ble
S:iving
:\S per-
!
f
~nt of : Popula-
j
~!1:s- /
per- 1 sand~)
sontu
income
c!h~~-
I
I
--'---il----"----'----'----j~i=•=•o~m~~---1 ___
C
urre1:1t
dollars
197 2 1 C urreni
dollars 1 dollars
1972
dollars
personnl
·1
1
_ _ _ _ _ _ _ _•_rn_e_a_~_ _ __;__ _
Billions of dollars
1969______
19i0______
19il______
19;2______
745.
801.
859.
942.
Dollars
81' 115. 4
3 l 15. 3
l 116. 3
630. 4
68;;. 9
742. 8
595. 3
635. 4
685. 5
5 141. 2
801. 3
751. 9
:~i g
rnn::::::
~: ~it i! gg: ~ i~1 ~
l9i5 ______ 1. 2.53. { IG!l. 0 1,084.4
t, 00·l 2
19,u-•••••• I, 362. 71 106. 9 11, 18.5. 8 I, 119. 9
1077 ______ il, 536. 71 227. 5 ,1, 3()(J. 2 ,1, 241. 9
1
1970: I ••• !1,
II ••• il,
Ill.., I,
IV __ 'l,
338.
366.
39:l.
432.
l.
7,
9
21
164.
192.
200.
200.
8
6
6
5
11, 153.
11, 1.4.
I, 19:l.
l, 222.
3
1
3
G
I
J, 060.
l, 103.
J, 128.
1, 166.
91
8
5
3
11'
--:1, 603.
l
6
3
4
3
71. 7
80. 2
65. 9
67. 3
3, Ill
3,348
3,588
3,837
4, 2S5
4,646
5,077
5,511
6,037
0 234. 7 1,368. 3 1,292.2
I
5,374
70.
72. •3 1 5, 4G2
64. 8
5,540
56. 3
5, 6G5
5, 703
51.
68. 541 5,967
73. 3
6,098
76. I
6,290
tn!5~:~=~=~s;.r:::~'
J~~~~t~~~!r:~1~tf~::rK~~~~~S~'d by consumers to
Jnclu,les Auued 1:ottN111Lrood. Annual dara are ror July I thron,:h 1!173 1md
1
\
3,020
3,227
3,510
3,8-19
4, 197
4,591
5,064
5,585
3,234
3,265
3,342
3,510
3,648
3,589
3,629
3,817
3,971
4,921
5, 01S
5, 117
5,278
5,422
5,513
5, Gl5
.5, 790
3,761
3,704
3,820
3, SOI
3,933
3,943
3,964
4,0H
2,860
L5
3. 0
2. 6
3. 3
5. g
-2.2
202, 677
204, S78
207, 053
20S, 846
210,410
211,945
213, 566
5. 6
7. 4
7. 7
6. 2
7. 8
7. 3
7. 4
1.0
3. 1
3. 8
tt m:~g~
4.5
6. 3 : 21-1, GOS
I
4, 107
4,130
4, 135
4, 177
4,202
4,268
4,305
4,394
2. 3
'5
4.1
2. 4
6. 4
3. 5
8. 5
;: ~ )~it ~is
0
4. 6
215, 827
-t. l: 21fl,20G
5. 31216. 603
5.5 217,073
5. 6 217,541
Souret1: Dep:irunent of Couunorce (Bureau ol ECOMmic Aoalysls Gad Duuau
oltlteC•nsusJ.
~!;:rr111n Clf 11u•rtuly data l.:r1lon1nc H/;'4. quartrrl) data aro BH•"'e for tl,e
Reproduced trom Economic Indicator1, March 1978,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
3,515
3,619
3,714
3,837
4,062
3,973
4,014
4, 137
4,293
Season:illy adjusted nnnual r:ites
1011: 1..__ !1, 476. 81 224. 4 1, 2s2. • 11,201. o
·
II. __ 1, 517. 21 224. 8
292. 5 I, 223. 9
Ill .. 1I, 5-19. 81 22G. I I, 32~. 8 !, 250i 5
IV
35.
50.
57.
49.
70.
235
CRS - 23
NEW CONSTRUCTION
I
Total new
construetioo
Period
expendi-
Private
Total
tures
Construction cootract.,1
I
Residential
I
Total 1
ICommer-
New
cial nod
housing : industrial
units
110.0
124. 1
1973 •••••••••••
1974 ...........
1975 ••••••••••.
1976 •••••..•.•.
137. 9
138. 5
134. 3
147. 5
1977•-----------
170. 7 I
43.
54.
59.
50.
46.
60.
81,
80.1
93. 9
105. 4
100. 2
93. fi
109. 5
133. 7
I
and
local
Other
I
I
Billions of dolfars
19;!
____________
1972••••••••••••
j CommerTotal value· ciru and
index
industrial
(1907- floor
space
100)
(mil1ions of
squn.re feet)
Federal,
State,
3
3
7
4
5
5
1
I
35.
44.
50.
40.
~4.
17.
18.
21.
23.
20.
1
9
1
6
4 I
47. 3 :
65. I J
I
0
1
7
8
8
19.
21.
24.
25.
26.
29.
30.
19. 9
21. 8
8
5
0
9
3
0
32.
38.
40.
38.
37.
8
351
7
0
0,
4
3
5
7
!l
4
I
252. 2
I
145.
165.
179.
169.
1G7.
]99.
29. 91
30. 2
727
854
1,010
840
555
592
738
·------18
Seasonally
!JJ::,~~v
adjuated I annual
19';7: J':,.n _______
Feb _______
Stasonally adjusted annual rate,
II
f----~-----------------------:• ~,~~
rates
Mar ......
tr:i::::::
June ______
July ••••••
Aug _______
Sept •••••• !
g~~--:::::1
Dec •••••••
107S: Jan•-- ___
l
116. 2
148. 1
156. !)
163. 8
167. 5
172. I
174. 6
173. 0
172. 0
175. 9
177. S
177. S
66.
72.
76.
79.
82.
82.
80.
122. 4
128. 4
131. 3
133. 7
135. 2
133. 8
133. 8
136. 7
140. 1
142. 1
143.0
130. 5
180. 2
173. 2 j
so.
5
I
7
5
52. 3I
58.
62. 2
63."
1
I
18.
20.
21.
20.
22.
22.
~~ gi
4
5
8
7
65.
65.
66.
68.
70.
73.
67.
82. 4
8.~ 7
87. 7
00. 0
84. 3
, IDcludu nonhousekHplni: ruidtntlal con5truction and additions and alttr•
alJon,, not shol'"D s,r,antely.
1 F. W. Dod~ tt-rlts. RtlMH lo ~ Stain btr.lnnlni; l!IGt for nh.1e lndt1 and
bfi;1111,1nc l!m for floor space.
I
1
4
8
4
0
7
22.
30. 9 I
31."
30. 9
I
871
8
l
9
:n1
30. 4 •
3
ao. 2
7
!l
5
4
1
8
23.
23.
23.
21.
21. 1
30. 2
30. 8
31. 0
31. 4
32. l
33. 4
I
32. 0
34.. 5
31;. 4
36.
38.
39.
39.
38.
39.
37.
212 I
207
615
309
2
250 !
6il
4
317
7&8
4
2
307 1
21R
2G7
2
3
7
I
27!)
I
299
270
~
864
996
•m.
35. fi
36. 3
33. 1 11
733
702
8.53
813
m
N0TE.-1't•· construction upendltures d•t• prfOI' to 197:Soot compvabl•wltb
laterdatL
Sour~: Dtpartment or l'ODlmtrct CDur,au of tht Cfnsus) and McCiraw-HIII
Information :Orst,ms Company, r. W. Dodi:, D!Ti~lou.
NEW PRIVATE HOUSING AND VACANCY RATES
(Thou;:innds of units or homt':J, t":otccpt n.s notedl
New pri,rate housing units
Period
Units st.:mc<l. by type of structure
Total
/
1 t:nit
I
2-4
mt-::::::::: H!U. d!U
u;i~i
mt::::::::::
uin
19,j ••••••....• 1,160.4
'Ag
64.0
·m:i
1
1976.... ••.....
1977•...........
1, 537..5
I, 087.1
802.2
1, 162. 4
1,450.9
1977: Feb _______
Mar ______
1, 751
1,362
85. 9
121. 7
15 or ~ ore I
Units
a.utho
ize/-
I New private homes
I
j
Units
completed
I
llom<'S
sold
urdi I H!U !:~i! ·--Hi
::m::
i:ti
204.3
939.2
289. 2
1, 20H. 2
414. 4 I 1,676.6
~:~g~t
1,317.2
I, 377. 2
I, 654, 5
in
549
646
819
11 Vacancy
r~te for
Homes for :1 rentnl
sale at l'I housing
en':1 of
unit...
per,oiii (perce"i'i
1
11
1
~!i
3131
t~
354
40j
6.0
5. 6
5. 2
355
·····•·s. 1
3G4
•••••• 5. 3
Seasona.lly adjusted :mnu&.1 rntes
~f::r::::::
June ______
July ______
Aug _______
i~~~::.::::
Nov _______
Dec•------
1g;s: Jan • _____ i
teb~~-----J
2,000
1, S99
I, 982
I, 931
2,072
2,038
2,012
2, 1:io
2,096
2,203
I, 547
J. ~~2.
1, 4S9
1,433
I, 409
1,406
1, 4.53
1,454.
1,508
l, 532
l, 544
I, 574
I, 155
I, 091
1s,a.sonallyaJ1u.stl'.'d.
• Quarkrl)• data tnlt'ttd in l:i~I month of quutt'J'.
116
114
118
120
113
124
119
124
127
134
153
100
S6
1,526
1,687
1,605
l, (i15
273
487
348
393
412
1,678
I, 639
1, 772
1, 6!):j
1, 8[)0
1,893
495
465
3SO
480
418
476
292
403
l, St 1
I
I, 566
I, 557
1,655
I, 671
1, 6i7
1,875
1, liGf>
1,769
1,630
1,721
826
88.j,
784
810
806
722
818
845
870
818
647
762
1·········· ..........
358
362
307
375
JS9
369
39S
402
5. 4
405
5.1
407
----------
NoTE.-ll.lla for umb -:ompl, ttrl r-:v1sed c,e1unmn1 l!r.2 ,md homes sold and
fotll'\le l•,•elnmm: 1~::1,
Sour~i!; D"partin,ut of Conimt>rtt, DurHu or tbe Census.
Reproduced Croa Econoa1c Indicators, March 1978,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I, 496
1,622
1,610
1,070
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
BALANCE OF PAYNENTS
ON CURRENT ACCOUNT (LINE)
AND ON NERCHANDISE TRADE (OOTJ
4
Cl)
0::
2
2
0
0
.·-.
a:
...J
a
Q
'
-2
"0
en
2:
0
H
.'
...J
H
-2
("'J
~
Cl)
I\)
-4
-4
__,
C0
4
'
.•.
'
-6
.. 9
-6
.•. -.- ·.
-8
'•
-10
-10
1573
1574
1975
1976
1977
1978
Data source: Department of Commerce, Bureau of
4/19/78
Economic Analysis.
Prepared by Congr~ssional Research Service, Library of Congress
+
I:.,;)
c...:i
~
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
9
...
:z:
INCOME VELOCITY OF "ONEY l"1)
PERCENT CHANGE FROH SAHE QUARTER. PREVIOUS YEAR
---
9
8
8
7
7
6
6
5
5
0
~
(/)
LU
u
QC
UJ
Q..
I\)
4
4
1973
1974
1975
1976
1977
1978
41'191'78
Data sources: Board of Governors of the Federal
Reserve System and Department of Commerce, Bureau
of Economic Analysis.
Prepared by Congressional Research Service, Library of Congress
"'
t-.::i
w
-..J
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
INTEREST RATES
FEDERAL FUNDS RATE CLINE)
AVERAGE YIELD ON 6 "ONTH TREASURY BILLS COOT)
EFFECTIVE YIELD ON NEU HOflE flORTGAGES ( DASH l
1 4 r - - - - - - - - - - - - - - - - - - - - - - - - - . 14
12
12
0
::i:J
....%
0
10
'- ...__-...__.._.,,..---..__
w
u
w
°'0..
8
6
.-·... '.
____ -
10
(/)
r\)
l~
t-:i
i:,.:i
8
6
4t-----1----+----+----+----+---~4
1S74
1975
1976
1977
1978
1973
Data sources:. Board of Governors of the Federal
·4/17/78
Reserve System, Department of the Treasury and
Federal Home Loan Bank Board"
Prepared by Congressional Research Service, Library of Congress
00
@FedFRASER