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Fox Release on Delivery Expected at 10:00 a.m. (E.S«T«> January 30, 1979 Statement by G. William Miller Chairman, Board of Governors of the Federal Reserve System before the Joint Economic Committee January 30, 1979 Mr. Chairman, members of the Joint Economic Committee, I appreciate the opportunity to participate on behalf of the Federal Reserve Board in your annual hearings on the state of the economy. We find ourselves at an important juncture in our nation's economic progress, a time when patience and persistence are needed until the nation's anti-inflationary economic policies begin to achieve significant results. The current expansion in economic activity has now almost completed its fourth year—an impressive performance by historical standards. The rate of economic growth moderated somewhat in the past year, yet employment gains were exceptionally large, and major imbalances generally associated in the past with a maturing business expansion did not materialize. developments. There were, however, a number of disturbing In particular, the rate of inflation, already far too high, accelerated further, the foreign exchange value of the dollar declined substantially prior to November, and the level of consumer debt rose sharply* Outlays for business fixed investment grew strongly in 1978, and housing activity remained at a high level through the year-end. Consumer spending, buttressed by further large increases in consumer credit, continued to provide support for the expansion. Total employ- ment rose by more than 3 million persons during the year; although the labor force also increased rapidly, the unemployment rate declined about 1/2 percentage point to just under 6 per cent at year-end. -2- The further expansion in economic activity last year appreciably reduced the margin of unutilized resources in the economy. Skilled workers were in increasingly short supply, and industrial capacity utilization rates moved closer to peaks reached in recent cycles* In these circumstances, the moderation in economic growth last year was a desirable development since a more rapid rate of expansion in aggregate demand could well have exacerbated our already serious inflationary problems. The general level of prices rose sharply in 1978, with the rate of inflation accelerating to about 8-3/4 per cent compared with 6 1/2 per cent in 1977. While the moderation in the pace of economic expansion and the lack of significant distortions in major sectors of the economy augur well for the economy's further expansion in the months immediately ahead, the longer-run performance of the economy will depend critically on our success in bringing down the rate of inflation. Containment of inflationary pressures in our domestic economy is also a major prerequisite for strengthening the dollar in foreign exchange markets while reducing our trade deficit. In 1978 the deficit was about $35 billion, on an international accounts basis, and the value of the dollar against major foreign currencies fell 17 per cent over the first 10 months of the year. Since November 1 when new domestic monetary policy actions and dollar support measures were initiated, the dollar has risen about 7 per cent. The vigorous implementation of the support program through cooperative exchange market intervention has -3- been successful* The expansion of Federal Reserve swap arrangements and the marshalling of other resources have proved very useful in correcting the excessive decline of the dollar. However, the longer- run strength of the dollar will depend on reducing our domestic inflation, increasing our exports, and curbing our oil imports. Another worrisome aspect of our economy's performance has been our lagging rate of productivity growth. The poor performance of productivity has retarded the rise in living standards and aggravated the inflation problem* There are many causes of this retarded growth, some of which hopefully reflect temporary developments, but tax policies that pay insufficient attention to investment incentives and government over-regulation must rank high among the contributing factors. In domestic financial markets, conditions have tightened considerably over the past year. Since the beginning of 1978, short-term interest rates have; increased 3 to 4 percentage points; mortgage rates about 1-1/2 percentage points; and bond yields about 1 percentage point. Despite higher interest rates, funds for creditworthy borrowers have remained in ample supply. The total volume of net funds raised in credit markets was lower in the second half of 1978 than in the first half, but total credit flows remained large as borrowing by households in the form of mortgages and installment credit continued to expand at a rapid rate. ' The acceleration of inflation over the past year has required major adjustments in economic policies. In the fiscal policy sphere -4there has been a dramatic movement toward tighter control over government spending and a related reduction in current and prospective Federal deficits. The deficit specified for fiscal 1979 in the First Concurrent Budget Resolution was $60 billion, but this was cut to $39 billion in the Second Resolution. This very impressive reduction was a result of highly commendable actions by the President and the Congress that cut contemplated expenditures and moderated proposed tax reductions incorporated in the original financial plan for the year. More recently, President Carter has announced a budget for fiscal 1980 that would reduce the yearly deficit further--to $29 billion, by far the lowest level in 6 years. There seems to be widespread support for this initiative, and the prospects favor a further move toward budgetary balance in fiscal 1981 and actual balance by fiscal 1982, if not before. A second policy initiative in the fight against inflation was the Administration1s introduction on October 24 of a broad-based program calling for voluntary moderation in wage and price actions, the establishment of specific standards for wage and price increases, and the offer of various incentives for compliance. Past experience has suggested that incomes policies are of limited effectiveness in reducing the underlying rate of inflation. Yet, an incomes policy can play an important role in circumstances where more basic economic policies are being redirected in a vigorous way toward the containment of inflation. I am confident that most business and labor leaders will abide by the spirit of an incomes policy if they perceive that the -7- liquidity of many individuals, business concerns, and financial institutions is likely to exert a moderating influence on credit-financed expenditures. It should be emphasized that the much needed firming in credit market conditions has not been accompanied by the severe strains and distortions associated with past periods of credit restraint. Current interest rate levels may be inhibiting some potential borrowers, which is the objective of credit restraint, but creditworthy borrowers continue to find funds available at prevailing rate levels, The housing market in particular has continued to attract a relatively abundant share of financing, though at rising interest rates, A key factor in this development was the introduction in June 1978 of new 6-month money market certificates that have enabled depository institutions to attract funds by paying prevailing market interest rates. In addition, housing has been supported by the lending activities of the Federal Home Loan Banks, the emergence of new mortgage-related securities, and the improvement of secondary markets for mortgages. The net increase in mortgage debt in the fourth quarter of 1978 was only a little below the record increase in the fourth quarter of 1977. Mr. Chairman, you have asked me to assess the economic outlook. The major threat to the economy is inflation and the concomitant expectations that dominate the setting of prices and wages. Thus, any weakening in our anti-inflationary resolve could seriously damage our domestic economy and have adverse implications for the external value of the dollar. -8- Policies of fiscal and monetary restraint--together with the cooperation of business and labor in the Administration's wage-price program--can achieve a gradual reduction in the rate of inflation, with progress becoming evident during 1979. While growth of output and employment is expected to slow this year, a recession is unlikely in the absence of outside disturbances to the economy# A moderate rate of economic growth is likely to avoid financial and economic dislocations9 such as overinvestment in business inventories, which in turn could foster a recession later. The economy is already quite close to full employment and any new surge in demand must be prevented since it would only be translated into more inflationary pressures. Spending by consumers, a mainstay of our economic expansion since the spring of 1975, will probably continue to grow but at a reduced pace in light of the increased consumer debt burdens noted earlier. Expenditures on new plant and equipment by businessmen seem likely to be well maintained and they may even increase more than is currently anticipated if visible progress is perceived in the fight against inflation. In the housing area, some decline from the current high level of activity seems probable as financial restraints exert a retarding influence on both builders and homebuyers. Nonetheless, the severely depressed conditions that have periodically affected this sector of the economy will most likely be avoided. will continue Adequate financing to be available thanks to the wide range of government support programs and the access of home-lending institutions to market -9- sources of funds such as the new 6-month certificates. Prospects for our trade balance in 1979 also seem to be brightening. In your letter inviting me to these hearings3 Senator Bentsen, you have asked for comments on the appropriate mix of fiscal and monetary policies. In the area of monetary policy^ the restraint that has been put in place is achieving welcome results in the form of a reduced rate of monetary expansion. As may be seen from charts 6 to 8 S the monetary aggregates have generally moved into the ranges set by the Federal Open Market Committee, The Federal Reserve is determined to achieve a rate of monetary growth that is consistent with the objective of fostering a decline in the rate of inflation while encouraging moderate economic expansion. The Federal Reserve's task will be eased immensely if fiscal policy remains on the course outlined by the President,. Large budget deficits tend to put upward pressure on interest rates as Government demands compete with private demands for funds. It is therefore essential for the Congress to resist programs that lead to increased expenditures, A reduced Federal deficit, including borrowings by offbudget agencies? would ease pressures on interest rates and allow the Federal Reserve to achieve its monetary growth objectives at lower interest rates than otherwise. A reduced budgetary deficit would also foster a financial environment that encourages greater business investment and would improve the prospects for a period of sustained economic growth and a moderating rate of inflation. Chart 1 Change from previous period, annual rate, per cent REAL GNP 197 2 Dolla rs — I i I I I I UNEMPLOYMENT RATE I Per cent I Change from previous period, annual rate, per cent GNP PRICES TOTAL 10 1974 I 1975 I 1976 1977 I 1978 Chart 2 COMPONENTS OF FINAL SALES Trough, 1975Q1 = 100 1972 Dollars Residential Construction 160 140 120 100 Business Fixed investment 1975 1976 1977 1978 Chart 3 PRIVATE HOUSING STARTS Annual rate, millions of units Total 2.5 2.0 1.5 1.0 DEPOSIT GROWTH AT THRIFT INSTITUTIONS Change from previous period, annual rate, percent 20 15 10 OUTSTANDING COMMITMENTS AT SAVINGS AND LOAN ASSOCIATIONS 1974 1975 Billions of dollars 1976 1977 1978 Ch«rt4 March 1973=100 WEIGHTED-AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR* MPM Monthly 104 100 96 92 88 84 I I I t L I I I L t I t i i i 1 i i t I 1 I i 90 — . 92 — 88 — 84 80 1 Sept. 7 8 29 Nov. '78 * Index of weighted average of G-10 countries plus Switzerland. Weights are 1972-76 global trade of each of the 10 countries. 26 Jan. '79 Charts US. MERCHANDISE TRADE AND CURRENT ACCOUNT BALANCE Annual rates, seasonally adjusted, billions of dollars 50 r 40 30 20 CURRENT ACCOUNT BALANCE 10 + 0 10 / \ 20 TRADE BALANCE International Accounts Basis r 30 40 i 1971 i 1972 i 1973 i i 1974 1975 i 1976 50 1977 1978 Chart 6 Recently Established M-1 Growth Ranges and Actual M-1 Billions of dollars 375 S Q3 '78—Q3 '79 _ * 2% 365 6%% 355 365 J 355 335 - 365 325 l_ J355 335 "1365 325 - 355 335 - 345 325 _ 335 335 r 325 1 1 I I 1 1 1977 325 1978 1979 Chart 7 Recently Established M-2 Growth Ranges and Actual M-2 BilKons of dollars —1945 930 -915 - 900 1977 1978 1979 Chart 8 Recently Established M-3 Growth Ranges And Actual M-3 B»ons of dollars M640 19% > f 1610 Q3 78—Q3 T9 S 1580 y'-y™ 1550 1520 1490 ^ 10% / Q2 '78—Q2 '79 1550 1520 1490 1550 .10% r Q1 T8—Q1 r79 1520 1490 1550 1520 1490 ^•7%% 1460 o' Q4 '77—Q4 '78 1430 1400 1370 1340 J 1977 I I I I I I II 1978 J I I I I II 1979 1310
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