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For release at 12 N o o n Ea s t e r n Daylight T i m e Friday, S e p t e m b e r 6, 1963 E c o n o m i c Outlook R e m a r k s of G e o r g e W . Mitchell M e m b e r , B o a r d of G o v e r n o r s of the Fed e r a l R e s e r v e S y s t e m at the A n n u a l M e e t i n g of the A m e r i c a n Statistical Association Cleveland, Ohio S e p t e m b e r 6, 1963 The f o r e c a s t s e s s io n o f the A m e r ic a n S tatistical A s s o c ia t io n is a long standing tradition which I su sp ect is headed f o r the t e c h n o lo g ic a l ca su a lty list, f o r there is nothing about b u sin ess fluctu ations, with w hich this s e s s io n is co n c e r n e d , that is in ev ita b le. The s o u r c e o f o v e r - e x p a n s io n and o v e r - c o n t r a c t i o n in the e c o n o m y is the la ck of fa cts and understanding on the part o f b u sin e ssm e n , c o n s u m e r s , and public p o lic y m a k e r s . Not all ig n o ra n ce and uncertainty can be r e m o v e d f r o m our a c tiv itie s , but the e c o n o m e t r ic ia n s , sta tisticia n s, and e l e c t r o n ic data p r o c e s s o r s are ce rta in ly r e d u c i n g - - o r are about to r e d u c e -—expendable u n certainty in e c o n o m ic knowledge both fo r b u s in e s s m e n and p o lic y m akers. I am on y our f o r e c a s t s e s s io n as these te ch n o lo g ica l changes are in p r o c e s s - - t o o soon to deny I have a useful function, too late to p reten d the c o u r s e of events in the com in g months w ill not be m o d ifie d by p rivate and public p o lic ie s aim ed at averting the v e r y events I am trying to p re d ic t. I can only hope that the e c o n o m e t r ic ia n s w ill soon get the " p r e lim in a r y m e th o d o lo g ic a l p r o b l e m s " settled and begin estim a tin g rea l rather than im a g in a ry stru ctu ra l eq u a tio n s“ future outlook s p e a k e rs fo r this A s s o c ia t io n will then be o b s o le s c e n t . For today m y r e m a r k s w ill be institutionalist in c h a r a c t e r with the tra dition al sea son in g s of c o m m o n sen se, judgm ent, and a n a ly sis. *2« Features of Recent Development» L e t m e start b y briefly reviewing s o m e of the important features of our present e c o n o m i c situation. T o d a y m a n y c o m m e n t a t o r s on e c o n o m i c trends are pointing with considerable satisfaction to the present cyclical expansion. T h e y can note that in the third quarter of this year, real G N P is s o m e 11-1/2 p e r cent above the cyclical high of the spring of I960. This is an annual rate of increase of m o r e than 3-1/2 p er cent. It is a better p e r f o r m a n c e than in either 1957-60, or the four years f r o m 1953-1957 w h e n the annual rate of increase a v e r a g e d less than 3 p e r cent. Industrial production h as risen over 4 per cent a ye a r since the spring of I960, also a m u c h better re co r d than at a n y time since the K o r e a n War. T h e s e historical cyclical c o m p a r i s o n s are i m p r e s s i v e and in s o m e d e g r e e properly so. H o w e v e r , the technique of c o m p a r i s o n is suspect a nd admits of so m u c h manipulation that I question w h e t h e r it should be u s e d at all. If, for exam pl e, the results are not pref er i m p r e s s i v e on a p e a k to p e a k basis, one can try trough to t r o u g h -point of inflection to point of inflection--trough to p e a k - - o r p e a k to trough. If these don't w o r k one can refer to the total expansion in a cycle or refer to the av erage m o n t h l y e x pa ns ion --if n e c e s s a r y on am annual rate basis. T h e possibilities are such that a l m os t any cycl* ca n be m a d e to look im pr essively g oo d or bad. This is especially -3- true for a cycle that ha s not yet r e a c h e d a p e a k or trough. 1 w o u l d not go so far as to say that historical cycle c o m p a r i s o n s should be shunned, but they should be v i e w e d with considerable skepticism as they are m o r e likely to be soporific than significant for understanding or policy formulation. If one wa nt s to gauge p e r f o r m a n c e of the e c o n o m y — its action relative to its potential is a better standard. A n d b y this criterion the present output r ec o r d is lacklustre. In the p o s t w a r period prior to 1958, under-utilization of resources, w h e t h e r m a n p o w e r or industrial capacity, W a s n o m o r e than a short-run cyclical p r o b l e m . Since 1957, h o w e v e r , u n d e r utilization of re sou rc es has persisted throughout periods of cyclical expansion. Insofar as m a n p o w e r utilization is concerned, there is « little--or no--sign of i m m i n e n t i m p r o v e m e n t . A 5-1/2 to 6 p er cent u n e m p l o y m e n t rate over-all h a s m e a n t an 11 p e r cent rate for nonwhites a nd also an 11 per cent rate for the 14 to 24 age bracket F o r next year, the projected labor force increase is 1.0 million: for 1965, 1 5 million, of w h o m 900 thousand will be y o u n g people 14 to 24 y ear s of age. F u r t h e r m o r e , labor force g r o w t h h a s fallen 1/2 million behind projections m a d e not m u c h m o r e than a y e a r ago T o use these available labor resources, current rates of increase in output will h a v e to be significantly bettered, no m a t t e r h o w i m p r e s s i v e by previous cyclical experience G i v e n the declining participation ratio of labor force to population that h as -4recently prevailed, w e should expect that if rising e m p l o y m e n t d e m a n d s materialize they will induce a substantial labor force re-entry. This slack will h a v e to be taken u p before the statistical evidence of achieving our goal appears. S o far as business fixed capital is concerned, industrial capacity utilization has b e e n significantly b e l o w levels prevailing f r o m the spring of 1955 into 1957. M o s t recently, h o w e v e r , in June an d July, following the sh ar p spurt this year, manufacturing output, according to Fe de r a l R e s e r v e estimates, r e a c h e d 87+ pe r cent of capacity, the best s ho wi ng since the spring of 1959. But this is still significantly b e l o w the 92 pe r cent of late 3955. A n o t h e r distinctive --and c o m m e n d a b l e - - f e a t u r e of the y ears since 1957 is that they h a v e b ee n free of inflationary pressures. W ho le sa le prices of the b r o a d range of industrial c om mo d i t i e s , and prices of the m o r e sensitive industrial materials are, on average, little different today f r o m w h a t they w e r e 6 years ago. It is true that c o n s u m e r prices h av e risen a little over 1 per cent a year, m u c h of the rise is attributable to services. c-it F u r t h e r m o r e , quality i m p r o v e m e n t s in c o n s u m e r product s- -an d in a wide range of industrial products as well--suggest that official indexes hajve someu p w a r d bias over time. -5- In ma n u f a c t u r i n g , unit labor costs are about the s a m e as they w e r e in late 1958, a s ha rp contrast to the sustained and large increase in 1955, 1956, and 1957. Productivity gains in this expansion c o m p a r e favorably with gains in other p o s t w a r expansions. T h e increase since the spring of I960 h a s b e e n 14 per cent; in the c o m p a r a b l e three yea rs or so f r o m the s u m m e r of 1953 to the fall of 1956, the rise w a s only 11 p e r cent. A n o t h e r m a j o r influence in holding d o w n m anufacturing unit-labor costs has be e n the progressive s l o w d o w n in the rate of increase in w a g e rates and a verage hourly earnings. T h e r e are, of course, other features w o r t h y of c o m m e n t . The auto " b o o m " for the se co n d consecutive y ea r ha s b e e n exciting to s o m e a n d h as certainly contributed to expansion. In a c c o r d with the m o s t recent industry statements, ho w e v e r , I find p e r f o r m a n c e gratifying but hardly spectacular for the I960's. units should be the n o r m for the mid-sixties. S e v e n to eight million But spending for autos and parts--the best publicized of all c o n s u m e r outlays--nevertheless accounts for only 6 per cent of total c o n s u m e r p u r c h a s e s of goods a n d services. It is hardly n e w s w h e n c o n s u m e r spending rises--it has risen in 60 of the 66 quarters since the beginning of .1947. It is a r e c o r d that supports faith in the eagern es s of the A m e r i c a n c o n s u m e r to statistically sp en d m o s t of his i n c o m e o n "current" consumption. For example, w e find that c o n s u m e r s spent 92.4 per cent of their disposable -6- i n c o m e in 1961, 92. 4 p er cent in 1962, and 92. 6 p e r cent in the s e c o n d quarter of 1963. T h e s e are rates virtually'identical to the a ve rag e of the past d e c a d e and suggest that in recent years-«-as distinct f r o m early in the p o s t w a r period an d in contrast to the big c o n s u m e r spending splurge of 1955 relative to i n c o m e s ? - c o n s u m e r s , as a group, h a v e b e e n in a rather stable expenditure pattern. S o far as business spending is concerned, inventory accumulation started unusually early in this expansion period but inventory policies b y a nd large h a v e b e e n on the cautious side. b e e n an d continue low. Stock-sale ratios h a v e O n the other hand, spending for fixed capital, though sh o w i n g a cyclical rise and at last exceeding the 1956-57 highs, lags significantly relative to total G N P . It h a s b e e n for s o m e y e a r s-- and r e m a i n s today--a m a j o r cause of defaulted expectations for fuller utilization of m a n p o w e r and industrial resource«. T h e flow-of-internal funds to corporations h a s b e e n in r e c o r d v o l u m e a n d h as accelerated recently, rather unusual for 2-1/2 y e a re after a cyclical low. Profits before tax, though l o w e r relative tc G N P than earlier in the p o s t w a r period h av e o n the whole, with s o m e allowance for the effect of liberalized depreciation guidelines, continued to m o v e up, although irregularly, throughout the expansion; an atypical cycle development. A m p l e corporate funds h a v e not h a d the generative effect o n corporate spending that is often a s s u m e d . - 7- The Short Run Outlook Let m e n o w turn to the short run e c o n o m i c outlook. F o r the i m m e d i a t e future, i.e., for s o m e m o n t h s ahead, prospects are quite g o o d for a continuation of the recent m o d e r a t e increases in over-all activity. This is a p a c e that is hardly likely to m a k e a dent in the u n e m p l o y m e n t rate; or to raise the rate of industrial capacity utilization sufficiently to touch off anything approaching a fixed capital investment b o o m ; or to result in a n y strain on credit ma rkets; or to stimulate or support a n y significant ad va nc e in industrial prices. F o r the current quarter, G N P should be in the vicinity of $585 billion, annual rate; for the fourth quarter, $ 5 9 2 - 5 9 3 billion. If realized, these estimates w o u l d yield a total of $ 58 2 billion for y e a r 1963, at the u p p e r e nd of the Council of E c o n o m i c Advisor's beginning of the y ea r estimate of $578 billion + $5 billion. T h e Council' s estimate w a s predicated o n substantial tax reduction, effective July 1. This j u d g m e n t about the n e a r - t e r m future is b a s e d on a variety of considerations, including the following: 1. F ur t h e r expansion in Fe d e r a l and State a nd local p u r c h a s e of goods a nd services, with Fe der al outlays in the fourth quarter bolstered b y an ad va nc e of $1 billion, annual rate, attributable to p a y increases for the military. - 2. 8- F urt he r a dvance in business spending for fixed capital, in line with the C o m m e r c e - S E C surv ey released in June. Broadly speaking, the findings of this surv ey h ave b e e n supported b y a fairly sustained rise in n e w ord er s for nonelectrical m a c h i n e r y . 3. T h e pattern of housing starts this year, b a s e d o n the n e w l y revised seasonal factors, suggests that the high in residential construction activity probably o c c u r r e d in the spring or s u m m e r months. 4. S o m e decline f r o m these pe a k levels is likely. C o n s u m e r spending should k e e p pace with i n c o me s, with spending for nondurable goods m a k i n g a better s ho w i n g than the rather a n e m i c one in the first half of the year. A s y o u probably recall, retail sales c h a n g e d little f r o m late last ye a r to M a y . Most recently, with i n c o m e s continuing to advance, retail sales in June an d July b r o k e out above the earlier plateau, with spending strong for nondurable goods. 5. O n inventories, patterns in 4 of the past 5 years h a v e b e e n distorted by steel accumulation concentrated s o m e t im e in ti.v first half of the y e a r an d b y liquidation concentrated in the seconc half. This y e a r is n o exception, but the pattern is unlikely to be as acute as in other recent years; a cc um ulation has not b e e n so large a n d the rate of steel c o n s u m p t i o n is higher. T h e m o d e r a t e rise in rtew ordering for steel in July is consistent with this thesis. For inventories as a whole, accumulation is likely to be- tfown in the -9current quarter and to accelerate only m o d e r a t e l y in the fourth quarter. With supplies and capacity ample, and with d e m a n d s for go od s s h o w i n g only a m o d e s t further rise this year, incentives for large-scale accumulation are sim pl y not present. L o n g e r R u n Outlook T h e r e c o r d of the i m m e d i a t e past--including such f or es hadowing m e a s u r e s as n e w ord er s a n d c o n s u m e r a n d business surveys--is tenuous e n o u g h as a foundation for the n e a r - t e r m outlook; it is hardly an y support at all for an appraisal of prospective d e v e l o p m e n t s ov er the next 16 m o n t h s or so. F o r such an appraisal, b r o a d e r considerations m u s t w e i g h heavily in o n e ’ s judgment. It s e e m s to m e that national‘ e c o n o m i c policy--fiscal a n d m o n e t a r y - - w i l l be of crucial i m p o r t a n c e in shaping d e v e l o p m e n t s as w e get into 1964. Fiscal a n d m o n e t a r y policies m a y well be the decisive e l em ent s in w h e t h e r or not w e h a v e recession next year; they will certainly b e m a j o r e l e m en ts in rates of expansion a n d d eg ree of r e s o u r c e use for 1964 a n d beyond. F r o m fiscal policy, w e n e e d a combination of expenditure p r o g r a m s a n d tax reduction that w o u l d m o r e than m a t c h the increase in potential full e m p l o y m e n t receipts. Expenditure p r o g r a m s alone, as pr es en te d in the B u d g e t M e s s a g e for fiscal 1964 a n d in the light of d e v e l o p m e n t s since then, w o u l d be insufficient. This gives the - 10- e n a c t m e n t of tax reduction legislation, of the general o r d e r of m a g n i t u d e apparently being r e c o m m e n d e d b y the H o u s e W a y s a n d M e a n s C o m m i t t e e , a high priority. O n m o n e t a r y policy, a s s u m i n g that the private e c o n o m y will continue to generate a large a n d p e r h a p s g r o w i n g v o l u m e of gro ss savings, w e n e e d policies that at the least will not put u p w a r d p r e s s u r e o n l o n g - t e r m interest rates so long as u n e m p l o y m e n t r e m a i n s high, industrial capacity m o r e them ample, a n d inflationary pressures absent- -w he th er f r o m the d e m a n d or the cost side. S uch policies are essential for m a i n t e n a n c e of high levels of housing activity, for helping to e n c o u r a g e a n increased v o l u m e of business spending o n fixed capital, a n d for stimulating expansion in other credit using private areas. A m o n g the m a n y potentially adv e r s e c o n s e q u e n c e s of a continued serious balance of p a y m e n t s p r o b l e m is that m o n e t a r y policy m a y be called o n - - a n d m a y actually attempt--to raise short t e r m interest rates again, this t im e sharply. T h e con sequent effect on long rates, a n d m o r e importantly, o n the differential be t w^ er long a n d short rates is certain to h a v e a deleterious effect on d o mes ti c activity. -11- So fa r as the outlook is c o n c e r n e d the m o s t om in ou s co m b in a tio n o f public p o lic ie s f o r next y e a r w ould be a fa ilu re to enact substantial tax red uction co u p le d with an in c r e a s in g ly r e s t r ic t i v e m o n e ta ry p o lic y . I r e a c h this judgm ent on the c r u c ia l nature o f p o lic y fo r next y e a r b e c a u s e , without outside stim ulus, p r o s p e c t iv e dem ands at b e s t w ill p e r m it but a m o d e st, ir r e g u la r p a c e of expansion that w ill not be su fficien t to re d u ce the u n em p loym ent rate o r to p r o v id e adequate stim ulus f o r b u sin e ss spending on fix e d capital. We can re a s o n a b ly e x p ect F e d e r a l p u r c h a s e s o f g ood s and s e r v i c e s to continue to r is e next y e a r, but p ro b a b ly m o r e slow ly than this yea r; State and lo c a l spending to advance by $1 b illio n o r so a q u a rter; and c o n s u m e r p u r c h a s e s o f s e r v i c e s to in c r e a s e by $2 b illion o r m o r e a q u a rter. _Lf_disposable in c o m e s r is e , c o n s u m e r spending f o r nondurable g ood s. So fa r, so w ill so good. The c r i t i c a l u n certa in tie s in priv a te dem and are: consum er p u r c h a s e s o f durable g oo d s and housing, b u sin e ss fix e d investm ent, and in v en tory investm ent. U n certain ties e x is t a lso about the future c o u r s e o f e x p o r ts and im p o r ts . One r e c u r r e n t pattern o f re c e n t y e a r s that w ill be absent in 1964 is alternating influence on o v e r - a l l activ ity o f actual and p r o s p e c t iv e strik es in the steel industry. Taken altogeth er, these c r i t i c a l and sen sitiv e a r e a s might, at b e s t , give us a slight plus; they could, h o w e v e r , a ls o give a m inus big enough to p r e c ip ita te r e c e s s i o n . - 12 - W it h reasonably favorable public policies uncertainties in these critical areas w o u l d tend to be resolved o n the favorable side. Thus, with i n c o m e s bolstered b y tax reduction a n d with activity a n d e m p l o y m e n t expanding* a total of 1 Z. 5. miliioji.'housing, startsin 1964 is probable, a figure not v e r y different f r o m w h a t will be realized this year. F o r automobiles, another 7 million plus y e a r is reasonable in the light of continued g r o w t h in population, households, a n d i n c o m e s a n d the large a n d apparently rising v o l u m e of auto scrappage. T h e course of business investment m a y well be the determining influence o n over-all dev el o p m e n t s for next year. W e can expect the internal flow of funds to continue in large volume, incentives to invest to cut costs to r e m a i n strong, a n d expenditures for r e p l a c e m e n t s — n o w two-thirds of manufacturing investment-- to be substantial. Nevertheless, wh e t h e r spending will rise slow or fast or w h e t h e r it will decline, will b e d e t e r m i n e d largely b y incentives for e n l a r g e m e n t of capacity in manufacturing, the p r i m a r y incentive being the p r e s s u r e of output o n capacity. If recent utilization rates c a n be increased s o m e , or e ven maintained, in the m o n t h s i m m e d i a t e l y a h e a d a n d if favorable expectations for next y e a r ca n be engendered, say - b y tax reduction - m a n u f a c t u r e r s ’ plans for 1964 are likely to be o n the expansive side« a n d total business spending for fixed capital m i g h t well continue to rise for -13- s o m e time. I n e e d hardly r e m i n d you, h o w ev er, that m u c h w e a k e r m a r k e t s than a s s u m e d for housing, autos, a n d p e r h a p s c o n s u m e r nondurable g oo ds could materially affect investment plans a n d spending for 1964. If final d e m a n d s turn out m o r e or less as developed today, I w o u l d expect inventory investment to be a n essentially neutral factor next year, with accumulation at a m o d e r a t e rate. Le t m e c o m m e n t m o s t briefly o n prospects for o ur current account in the balance of p a y m e n t s , i. e . , exports a n d i m p o r t s of goo ds a n d services. unfavorable. T h e outlook for exports is not o n balance I don't envisage o ver the next 16 m o n t h s or so a ny m a r k e d departure f r o m d o me sti c industrial w a g e a n d price trends of recent years, w h i c h h a v e tended to maintain the U. S. competitive position in w o r l d m a rk et s. M o r e o v e r , business conditions in W e s t e r n E u r o p e -- a n d p e r h a p s e l s e w h e r e -- a p p e a r to be in a n expansive phase. Let us not forget, h o w e v e r , that W e s t e r n E u r o p e a n d J a p a n r e m a i n highly competitive in important w o r l d markets. -14- But even if e x p o rts of g ood s and s e r v i c e s are m aintained, o r are even in c r e a s e d m o d e r a te ly , would the next e x p o r t b a lance be e r o d e d by a surge in im p o r ts if d o m e s tic a ctivity should m o v e to h igh er l e v e l s ? T h e r e are s e v e r a l re a s o n s f o r discounting the lik e lih o o d o f this. F ir s t , im p o r ts in r e c e n t y e a r s have not grow n as fa st as GNP. Second, stock s of im p o r te d m a t e r ia ls appear to be in c l o s e r balance with the le v e l of d o m e s tic a ctiv ity than p erh a ps any tim e in the p ostw a r era , and there is no re a so n to e x p e c t any sudden d istu rb a n ce o f this balance as d o m e s tic a ctivity m o v e s to h ig h er le v e ls. On the whole, then, a tentative p r e d ic tio n o f “ little change” m a y be the b e st g u e s s one can m ake with r e g a r d to the d ir e c t im p a ct of international tra n sa ctio n s on the le v e l of U .S . e c o n o m ic a ctivity o v e r the next y e a r o r so. T h e r e d oes not s e e m to be ¿-.ny re a so n fo r expectin g sharp im p r o v e m e n t in the c u r r e n t a ccoun t of the b alance of paym ents in the n e a r - t e r m . -15- P o l i c y Issues I turn now to the p r o b le m s p o lic y m a k e rs fa c e and the e ffe c t of their d e c is io n s on the b u sin ess outlook. The p r o b le m s are the d e ficit in the ba la n ce of paym ents and a slu ggish growth rate in the d o m e s tic e c o n o m y with consequ ent unem ploym ent. If I debate m o r e than I d is c u s s p o lic ie s to deal with these p r o b le m s , it is b e c a u s e that, in fa ct, is m y p o stu re . The fa ct that these is s u e s are d i s c u s s e d la te r ra th er than s o o n e r in m y a p p ra isa l of the outlook d oe s not m ean, as I ind icated ea rlie r, eith er that public p o lic ie s a re of s e c o n d a r y im p o r ta n c e o r that they a re p a s s iv e ly adapted to d e v e lop m en ts in the p riv a te s e c t o r . We a r e , of c o u r s e , dealing with an interdependent s y s t e m in which public and priva te a ction s influence and re a c t to each other. This r e c i p r o c a l rela tio n sh ip has always ex isted at le a s t im p lic it ly between d e v e lo p m e n ts and p o l i c i e s . Now, fo r the U. S. , there is an additional d im e n s io n to the link betw een public p o lic ie s and e c o n o m ic d e v e lo p m e n ts; n a m ely , the b a la n ce of paym ents and public p o l i c i e s to deal with it. In t o d a y ’ s w orld , the U. S. cannot n e g le ct either the d o m e s t ic o r the international p r o b le m . The question is, what a re the a p p ro p ria te p o lic ie s to deal with each of these p r o b le m s . In view o f the fa ct that the U. S. paym ents d e fic it is not of the tra dition al type, involving e x c e s s dem and at hom e attracting e x c e s s r e s o u r c e s f r o m a b roa d , m y view has b een that we should not use tradition al m eans to deal with it. R ather, g e n e ra l f i s c a l and m o n e ta ry p o lic ie s should be p r i m a r i l y a im ed at d o m e s t ic expansion while s p e c ia l p u rp ose instru m en ts are applied to the b a la n ce of paym ents p r o b le m . The re ce n tly p r o p o s e d in te re s t equ a liza tion tax is a step in this d ir e c t io n and, if needed, I would hope that additional m e a s u r e s can be d eve lop ed . - 1 6 - I shall now d is c u s s f i s c a l , m on eta ry , and bala n ce of paym ents p o lic ie s in turn. F i s c a l p o licy . - - T h e r e is little to add on the su b je ct of f i s c a l p o lic y beyond what I have said e a r lie r . A tax cut is highly d e s ir a b le as a contribu tion to a g grega te demand, e s p e c ia lly c o n s u m e r demand. Without this contribu tion , the lo n g e r run outlook is m uch w eak er. I am not in a p o sitio n to suggest the lik e ly c o u r s e of F e d e r a l expen ditures in the p e r io d ahead, with o r without the tax cut, but it is a r e a so n a b le a ssu m p tion that they w ill continue to advance, though p erhaps l e s s ra p id ly than in the past two o r three y e a r s . It is w orth pointing out, h o w ev er, that m o st evaluations of the im p a ct of the tax cut on a g g re g a te dem and a ssu m e that this im pa ct w ill not be co u n terb a la n ced by a slow dow n in F e d e r a l outlays. F r o m the f i s c a l p o lic y point of view , F e d e r a l spending should continue to expand rough ly in line with the growth of potential GNP. Putting this in other t e r m s , one m a y view the tax cut as a m eans of red u cin g the magnitude of the full em p lo y m e n t budget surplu s. The s iz e a b le surplus that is im p licit in the p r e s e n t budget acts as a d rag on e c o n o m ic expansion, f o r it puts too la r g e a burden on private investm ent to a b s o r b the savings which our eco n o m y gen era tes at high and ris in g in c o m e le v e ls . If private investm ent is not buoyant enough to c a r r y this burden, and it has not been, we s u c c e e d in achievin g neither full em p loy m en t n or the budget su rplu s. The im p licit surplus can be re d u ce d eith er by cutting tax rates o r by in c r e a s in g expen ditures m o r e ra p id ly than full em p loy m en t tax rev en u es o r s o m e co m b in a tion o f the two. But it h a rd ly m a k es a p o lic y to use one too l f o r expansion and the other f o r co n tra ction . - 17 - M on e ta ry p o l i c y . - -D u rin g the past couple of y e a r s , m o n e ta r y p o lic y has attem pted to co p e with co n flictin g o b je c t iv e s . It has sought to e n co u ra g e fu ll u tiliza tion of r e s o u r c e s at hom e while a ls o m aintaining upw ard p r e s s u r e on s h o r t - t e r m in terest ra tes so as to m in im iz e in cen tiv e s f o r cap ital to flo w abroad. Opinions d iffe r on the d e g r e e of d o m e s tic stim ulation f r o m m o n e t a r y p o lic y in the past y e a r o r so. T h e r e a r e those who b e lie v e that m o n e ta ry p o lic y has b een e x c e s s i v e l y e a s y and f o r to o long a p e r io d , and has re s u lte d both in a s p illo v e r o f funds to oth e r co u n tr ie s and in a d e te r io r a tio n in the quality of c r e d it at h o m e . T h o s e who take this v iew support it b y pointing to the la r g e growth in c o m m e r c i a l bank loans and investm ents at a tim e when c r e d it dem ands w e r e not intense. L a st year., f o r exa m p le, c o m m e r c i a l bank c r e d it in c r e a s e d about 9 p e r cent as c o m p a r e d with a 5 p e r cent in c r e a s e in GNP. F r o m the trough of the r e c e s s i o n in e a rly 1961 to m i d - 1963, loans and investm ents at all c o m m e r c i a l banks in c r e a s e d about 20 p e r cent, while GNP grew 16 p e r cent. On this ev id e n ce , it is c la im e d that the banking s y s te m was b eing p r o v id e d with r e s e r v e s to m ake a substantial con tribu tion to the av ailab le c r e d it supply. It is n e c e s s a r y h o w e v e r , to analyze the c r e d it growth in its full context. A ll of the m o n e ta ry and c re d it m agnitudes in the past y e a r and a half have b een sig n ifica n tly a ffected b y the upw ard m o v e m e n t in in te r e s t rates paid on c o m m e r c i a l bank tim e and savings d e p osits fo llo w in g changes in the B o a r d 's R egulation Q, An im portant resu lt o f these in tere st rate changes was that c o m m e r c i a l banks b e c a m e m o r e a ttra ctiv e as fin a n cia l in t e r m e d ia r ie s . A substantial fr a c t io n - 18 - of the apparent growth in c o m m e r ic a l bank c re d it s im p ly r e p r e s e n t s a shift tow ard g r e a t e r interm ed ia tion , as b u s in e s s e s and ^individuals w e r e induced to in c r e a s e their c la im s in the f o r m of tim e and savings d ep osits at c o m m e r c i a l banks as a substitute f o r d ir e c t holdings of s e c u r it ie s o r c la im s on oth er fin a n cia l institutions. T o the extent that this type of shift o c c u r r e d , only a part of the in c r e a s e in total bank d e p o sits and bank a s s e t s should be re g a r d e d as constituting m o n e ta ry expansion o r as con tribu tion to total c r e d it expansion. The re m a in d e r re p r e s e n t e d a re channeling of the fin a n cia l flo w of funds as the p ublic added c o m m e r c i a l bank tim e d e p o s its rather than s e c u r it ie s to its financial assets. In fu rth e r su p p o rt.o f this interp reta tion of m o n e ta ry and c r e d it development^., I point to two significant fa cts . One is that the m o n e y supply, that is, dem and d e p o sits and c u r r e n c y , has i n c r e a s e d at an annual rate o f l e s s than 2 p e r cent in the past y e a r and a half. S econ d ly , the b e h a v io r of in te re s t ra tes d o e s not indicate that c r e d it sup p lies have b ee n e x c e s s i v e . S h o r t - t e r m ra tes have advanced and the d e clin e in lo n g - t e r m ra tes has been m o d e r a te . F urth erm ore l o n g - t e r m ra tes re m a in high by h is t o r ic a l standards. It is d ifficu lt to b e lie v e that long ra tes have d e clin e d by any m o r e than is a ccou n ted f o r b y the d isa p p e a ra n ce of the p r e m iu m e a r l i e r d em anded by le n d e rs with in flationary ex p ecta tion s. - 19 - It is fo r these r e a s o n s that I would c h a r a c t e r i z e m o n e ta ry p o lic y in the c u r r e n t upswing as having been p a s s iv e ly r e s p o n s iv e but not a c t iv e ly stim u la tiv e. F u r t h e r m o r e , I b e lie v e that w e r e it not f o r the bala n ce o f paym ents con strain t, m o n e ta ry p o l i c y w ould have done m u ch m o r e to e n co u ra g e e c o n o m ic expansion. The p o l i c y o f m aintaining and in fa ct in c r e a s in g s h o r t - t e r m in te re s t ra tes has a cted as a d ir e c t im p e d im en t to fu rth er re d u ctio n s in l o n g - t e r m ra tes w hich m ight e n co u ra g e higher l e v e ls o f d o m e s t ic investm ent. As long as sh o rt y ie ld s r e m a in high, le n d e r s have little in cen tiv e to m o v e out on the y ie ld c u r v e , fo r the c o s t o f rem ainin g liq u id is v e r y low . If we a re to e n co u ra g e ca p ita l fo rm a tio n , we n eed to m a ke s h o r t - t e r m a s s e t s l e s s a ttra ctiv e to le n d e rs so as to in c r e a s e the a v a ila b ility and reduce the c o s t o f lo n g - t e r m funds. M o n e ta ry p o l i c y has in a sen s e had one hand tied behind its back. It has not r e a lly had a chan ce to ex p loit the e la s t ic it y that e x is t s in the rela tion sh ip betw een l o n g - t e r m in te re s t ra te s and in v estm en t outlays. The p r o b le m is how can we give it a c h a n c e - - t h a t is, how can we p e r m it a red u ction in short- and lo n g - t e r m in te r e s t r a t e s - without aggravating our balance of pay m en ts. -20- Ba lance of p a y m e n t s policies. - - O u r balance of p a y m e n t s p r o b l e m m a y be characterized as follows: Although w e have an export surplus in t e r m s of goods an d services, w e are attempting to give a n d lend a b r o a d an even larger amount. T h e result is that the rest of the w o r l d is acquiring short-term dollar claims on the U. S. at a greater rate than it appears to wa n t them, while the U. S . , in turn, acquires lo ng - t e r m claims on the rest of the world. In real terms, a n export of capital w h i c h is not u s e d to pu r c has e A m e r i c a n goods a n d services does not represent a real bu r de n on the United States; it simply leads to a deterioration in our liquidity position. Ironically, the XL S. w o u l d be in less trouble internationally if the real b u r d e n of our capital exports could be increased. V arious policies have b e e n adopted by the U. S. G o v e r n m e n t to attempt to deal with this imbalance as b et w e e n our capital a nd current accounts. A m o n g the m a j o r approaches, aid is being tied to U. S. exports, a nd a tax has b e e n p r o p o s e d on lon g- t e r m capital outflows in the f o r m of portfolio investment. I believe these are steps in the right direction. Despite the criticism that has been levied at aid-tying by economists, it s e e m s to m e that this a p p ro ac h deserves e n c o u r a g e m e n t a nd further extension. If it could be i m p l e m e n t e d administratively, a g o o d case can be m a d e for tying all capital exports a n d unilateral outflows to U. S. exports. -21- The United States, g iv en its high r e a l in c o m e and even h ig h er p oten tia l in c o m e , is quite w illin g to p r o v id e r e a l r e s o u r c e s to the r e s t o f the w o r ld in the f o r m o f an e x c e s s o f e x p o r t o v e r im p o r t s o f g o o d s and s e r v i c e s . We get into trou b le in tern ation ally when we attem pt to e x p o r t d o lla r c la im s in an amount g r e a t e r than our c u r r e n t a c c o u n t su rp lu s. If we tie d ca p ita l flo w s to e x p o r ts , an adjustm en t w ou ld c o m e about in o u r b a la n ce o f p ay m en ts eith er through an in c r e a s e in e x p o r ts o r a red u ction in ca p ita l flo w s o r a com b in a tion of the two. Such a m e a s u r e w ou ld not, as I have said, r e s t r i c t the a b ility of f o r e i g n nations to tap r e a l r e s o u r c e s h e r e . It w ou ld s im p ly r e s t r i c t the e x p o r t of unused c l a i m s on us. I shou ld s t r e s s that by the t e r m " ty in g " I do not n e c e s s a r i l y m ea n a n a r r o w c o n c e p t o f financing s p e c i f i c e x p o r ts o f ca p ita l g o o d s . I w ou ld not want to rule out ca p ita l flo w s that con tribu te to the financing o f d o m e s t ic ou tla ys a b r o a d w h ich in turn induce g e n e r a l im p o r t s into the r e c ip ie n t co u n tr y f r o m the U. S. But in c a s e s w h e re the r e c ip ie n t cou n try d oe s not n e e d ou r r e s o u r c e s , d ir e c t ly o r in d ir e c tly , little p u r p o s e is s e r v e d by a flo w o f capital. It can a ls o be a rg u e d that a p o l i c y of this g e n e r a l nature w ould be p r e f e r a b l e f r o m both the d o m e s t ic and the in tern ation al v iew p oin ts, to a p o l i c y o f d i r e c t d is c o u r a g e m e n t o f ca p ita l ou tflow s b e c a u s e it w ould be l e s s lik e ly to d is c o u r a g e A m e r ic a n e x p o r ts . -22- F o r e c o n o m is t s , the c a s e against tying aid is b a s e d on the g e n e r a l b e l i e f that m u lt ila t e r a lis m m a k es f o r b e tte r r e s o u r c e use than b ila t e r a lis m . a g r e e m e n t. With this g e n e r a l p r o p o s itio n , I am in full What e c o n o m is t s n e ed to ex a m in e , h o w e v e r , is whether the c a s e o f ca p ita l outflow s (g o v e rn m e n t o r p r iv a te ) is a lso c o v e r e d by this g e n e r a l p r o p o s itio n . F in a lly , we n e e d to r e m e m b e r that we a re in the p o s it io n o f ch o o s in g am ong u n d e s ir a b le a lte rn a tiv e s. Tying aid and ca p ita l flo w s m a y have disa dva n ta ges in t e r m s o f r e s o u r c e a llo ca tion . B e f o r e we r e j e c t this a p p roa ch , h o w e v e r , we ought to c o m p a r e its c o s t s , both sh o rt and l o n g - t e r m , with the c o s t s of alternative a p p r o a c h e s to dealing with the balance o f paym ents p r o b le m . In p a r t ic u la r , fa ilu re to r e a liz e p oten tial output and em p lo y m e n t is a r e a l and substantial co s t . It should be apparent that in m y view the p o l i c y a ltern a tiv es in v olv ed in a ch ie v in g m o r e rapid e c o n o m ic grow th and re d u cin g our b a la n ce of paym ents d e fic it a re c r i t i c a l to the lo n g e r t e r m b u sin e ss outlook. The tra d ition a list f o r e c a s t e r has, h o w e v e r , no c le a r c r y s t a l b a ll f o r p r e d ic tin g the m o v e s of p o lic y m a k e r s . be a p p r o p r ia t e at all. F o r m e it would not
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