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THE ECONOMIC SITUATION Delivered by Harry A. Shuford, President Federal Reserve Bank of St, Louis at the Dinner Meeting for Retailers Hotel Stratford Alton, Illinois Wednesday evening, January 22, 1964 THE ECONOMIC SITUATION I have been asked to talk to you today about the p e r f o r m a n c e of the economy in 1963. As I do so I want to include how m o n e t a r y policy, the s p e c i a l r e s p o n s i b i l i t y of the F e d e r a l R e s e r v e System, affects this p e r f o r m a n c e . It is i m p o r t a n t that you, both as b u s i n e s s m e n and c i t i z e n s , u n d e r s t a n d how m o n e t a r y policy o p e r a t e s and the p r o b l e m s which it f a c e s . F o r , the extent to which it and o t h e r stabilization policies a r e successful has an i m p o r t a n t bearing on the p r o s p e r i t y of the nation, and our a r e a , including Alton. It is not easy to a p p r e - ciate the cause and effect r e l a t i o n s h i p between changes in m o n e t a r y policy and changes in economic activity. This is b e c a u s e the effects a r e so diffuse and b e - cause they m a y impinge upon us in a way which hides t h e i r o r i g i n . I like to think of the a s p i r i n a d v e r t i s e m e n t in which the tablet is dropped into the mouth of the s p i r a l e d t u b e - - a n d it is gone by the time it r e a c h e s the s t o m a c h . m e a n that the a s p i r i n doesn l t w o r k - - j u s t b e c a u s e you can't see it. This d o e s n ' t So it is with m o n e t a r y policy. One of the c l e a r e s t i l l u s t r a t i o n s of the r e l a t i o n s h i p of s a l e s , output, and employment to m o n e t a r y policy is to consider what happens to the economy during p e r i o d s of r e c e s s i o n . In the 1950's we had t h r e e brief, mild downturns, 1953, 1957, 19&0--in which total output fell on the a v e r a g e of 9.7 per cent and r e t a i l s a l e s by 1.4 p e r cent. In each c a s e the F e d e r a l R e s e r v e System engaged in m o n e t a r y o p e r a t i o n s which helped r e v e r s e the downward m o v e m e n t in b u s i n e s s and r e s t o r e p r o s p e r i t y . - 2 - In 1963 the System 1 s o p e r a t i o n s w e r e d i r e c t e d t o w a r d contributing to sustainable economic growth with r e a s o n a b l e p r i c e stability and a viable i n t e r n a t i o n a l p a y m e n t s position. Before mentioning the salient f e a t u r e s of m o n e t a r y developments in 1963, however, p e r h a p s I should briefly outline the ways by which the F e d e r a l R e s e r v e S y s t e m c a r r i e s out i t s m o n e t a r y policy. of m o n e t a r y policy a r e mainly t h r e e . These "instruments11 The m o s t i m p o r t a n t i s open m a r k e t o p e r a t i o n s , or dealing in money m a r k e t a s s e t s , mainly Government s e c u r i t i e s . When the S y s t e m i s buying, the r e s u l t is that r e s e r v e s of c o m m e r c i a l banks a r e i n c r e a s e d , which in t u r n m e a n s that bank c r e d i t i s m a d e m o r e freely available to the economy. The r e v e r s e i s t r u e for selling s e c u r i t i e s . A second i n s t r u - m e n t i s the F e d e r a l R e s e r v e discount r a t e , or the r a t e c h a r g e d m e m b e r banks when they b o r r o w from the F e d e r a l R e s e r v e B a n k s . A third, which w a s not u s e d during the p a s t y e a r , is changing the p r o p o r t i o n of r e s e r v e s to deposits that a r e r e q u i r e d to be held by the c o m m e r c i a l b a n k s . It is mainly by t h e s e t h r e e tools—open m a r k e t o p e r a t i o n s , the discount r a t e , and r e s e r v e r e q u i r e m e n t s - that we c a r r y out our r e s p o n s i b i l i t y for regulating the money supply in o r d e r to achieve the goals of growth, p r i c e stability, and i n t e r n a t i o n a l b a l a n c e . In r e t r o s p e c t , the economy had a good year in 1963. in the p a s t year has flourished. Retailing E s t i m a t e d s a l e s in Alton and in the St. Louis Metropolitan A r e a a s a whole w e r e significantly higher in 1963 than in 1962. F o r the e n t i r e nation, r e t a i l s a l e s w e r e up 4. 8 p e r cent. However, the g e n e r a l - 3 - b u s i n e s s outlook a y e a r ago was far from r o s y . Economic activity in the nation had been on a plateau since the s u m m e r of 1962, and p r o b l e m s of inadequate d o m e s t i c demand and b a l a n c e - o f - p a y m e n t s deficit w e r e t r o u b l e s o m e , a s they h a d b e e n for s e v e r a l y e a r s . T h e s e two p r o b l e m s - - i n t e r n a l and e x t e r n a l - - p r e s e n t e d a d i l e m m a in deciding on what m o n e t a r y policy should b e . To put m o r e l! zip !f into the d o m e s t i c economy, the p r e s c r i p t i o n would be one of m o n e t a r y e a s e . Reserves of the banking s y s t e m would be i n c r e a s e d to encourage c r e d i t and m o n e t a r y expansion, lower i n t e r e s t r a t e s , and, hopefully, g r e a t e r levels of spending. However, with our payments to f o r e i g n e r s exceeding t h e i r payments to u s , we w e r e losing gold and running a foreign deficit. F o r this m a l a d y we would not want a m o n e t a r y "pep pill, n but i n s t e a d a " t r a n q u i l i z e r , u or maybe a " s e d a t i v e . 1 1 To be m o r e specific, if we focused only on international c o n s i d e r a t i o n s , m o n e t a r y policy should have been r e s t r i c t i v e , tending to r a i s e s h o r t - t e r m i n t e r e s t r a t e s and thus to d i s c o u r a g e the movement of capital a b r o a d . R a t h e r than take e i t h e r of t h e s e e x t r e m e c o u r s e s , m o n e t a r y policy s t e e r e d a middle c o u r s e . Unused r e s o u r c e s in the economy made it p o s s i b l e for m o n e t a r y and other Government policies to be m o d e r a t e l y stimulative in that we did not have to be o v e r l y concerned that h i g h e r levels of spending would push p r i c e s upward. Throughout 1962 and indeed, 1963, c o n s u m e r and whole- s a l e p r i c e s r e m a i n e d r e l a t i v e l y stable and p r e s e n t e d no t h r e a t of renewed inflation. - 4 - T h u s , m o n e t a r y actions during the f i r s t half of the y e a r w e r e designed to f o s t e r expansion. M e m b e r bank r e s e r v e s r o s e f a s t e r than u s u a l and bank c r e d i t expanded at an annual r a t e of 11 p e r cent. C a s h holdings of the public w e r e r e l a t i v e l y l a r g e , and the money supply continued to expand moderately. In the f i r s t half of 1963, a rapid b u s i n e s s expansion o c c u r r e d . I n d u s t r i a l production r o s e at a 12 per cent annual r a t e for the f i r s t seven months of the y e a r . E m p l o y m e n t picked up nicely, and total spending on goods and s e r v i c e s was slightly higher than in the l a s t half of 1962. Important factors behind this u p s u r g e w e r e a strong i n c r e a s e in the demand for s t e e l (to build i n v e n t o r i e s ) , r i s i n g p r i v a t e construction s p e n d ing, and stimulative Government fiscal t r a n s a c t i o n s . Unfortunately, these favorable d o m e s t i c economic developments w e r e countered by a new r e s u r g e n c e of b a l a n c e - o f - p a y m e n t s difficulties. Despite the fact that our t r a d e position was strong and that the burden of G o v e r n m e n t aid and defense expenditures abroad was being m i n i m i z e d , the deficit for the f i r s t half of 1963 i n c r e a s e d sharply over 1962. i n c r e a s e d U. S. i n v e s t m e n t abroad. This o c c u r r e d because of L o n g - t e r m investment accounted for 70 p e r cent of the i n c r e a s e in the deficit, and s h o r t - t e r m i n v e s t m e n t s 25 p e r cent. T h e r e w e r e two i m m e d i a t e r e a s o n s for the i n c r e a s e d capital o u t flow m the f i r s t haK of 1963. In g e n e r a l , foreign capital m a r k e t s have limited r e s o u r c e s and a r e tightly controlled by g o v e r n m e n t s . T h u s , when foreign - 5 - capital needs r i s e during p e r i o d s of p r o s p e r i t y , foreign demands for U. S. i n v e s t m e n t funds i n c r e a s e . Second, as the i n t e r n a t i o n a l economy b e c o m e s m o r e i n t e g r a t e d and g r e a t e r confidence is placed in foreign c u r r e n c i e s , s h o r t t e r m i n v e s t m e n t tends to be guided.by the r e l a t i v e a t t r a c t i v e n e s s of home and foreign s h o r t - t e r m y i e l d s . In m i d - J u l y steps w e r e taken to attack this capital d r a i n . First, to m a k e borrowing costs in the U. S. for f o r e i g n e r s m o r e c o m p a r a b l e to c o s t s a b r o a d , an " i n t e r e s t - e q u a l i z a t i o n tax 11 was p r o p o s e d on foreign s e c u r i t i e s sold in the U. S. Second, s h o r t - t e r m i n t e r e s t rates in the U. S. were r a i s e d in o r d e r to m a k e i n v e s t m e n t h e r e r e l a t i v e l y m o r e a t t r a c t i v e . N o n e t h e l e s s , the F e d e r a l R e s e r v e System h a s continued to supply additional r e s e r v e s to the banking s y s t e m , and both c r e d i t and money have continued to expand. Since August, the pace of b u s i n e s s activity has m o d e r a t e d . I n d u s t r i a l output, employment, construction and r e t a i l s a l e s have i n c r e a s e d l e s s r a p i d l y , although c o r p o r a t e profits m a i n t a i n e d t h e i r healthy r a t e of i n c r e a s e . Although d o m e s t i c activity has paused, it has done so at r e c o r d high l e v e l s . Meanwhile, the b a l a n c e - o f - p a y m e n t s situation has i m p r o v e d d u r - ing the l a s t half of the y e a r as capital outflows g r e a t l y dixninished. Preliminary e s t i m a t e s for the l a s t half of 1963 show an i m p r o v e m e n t of $3 billion o v e r the f i r s t half, and the i m p r o v e m e n t in capital outflows l a r g e l y account for the r e d u c e d total deficit. - 6 To sum up for the y e a r as a whole s t a n t i a l growth. 1963 was a y e a r of s u b - Total output in constant d o l l a r s i n c r e a s e d 3 . 9 p e r cent, well above the a v e r a g e y e a r l y growth of 3. 1 p e r cent since 1951. Total employment r o s e 1. 6 p e r cent c o m p a r e d with 1.. 0 p e r cent p e r y e a r since 1951. 1963 was also a year of balanced growth and of sustainable growth. As I mentioned e a r l i e r , general p r i c e i n c r e a s e s did not a p p e a r o r t h r e a t e n to a p p e a r . And although we experienced a discouraging a d v e r s e b a l a n c e - of-payments situation in the f i r s t half of the y e a r , for the entire y e a r we m a n a g e d to i m p r o v e the deficit significantly over l a s t y e a r . The F e d e r a l R e s e r v e S y s t e m and o t h e r Government agencies have carefully coordinated policies t o w a r d t h i s goal and have managed to do so without imposing heavy costs on the d o m e s t i c economy. With 1963 providing a background, what l i e s ahead in 1964? There s e e m s to be a consensus among economic f o r e c a s t e r s and pundits that it will be a ,! good y e a r . M Total output for the nation, as m e a s u r e d by G r o s s National P r o d u c t is expected to be s o m e w h e r e in the neighborhood of $620 to $625 billion, an i n c r e a s e of about 6 p e r cent over 1963. If this f o r e c a s t p r o v e s c o r r e c t , then we might expect somewhat g r e a t e r growth in p e r s o n a l i n c o m e . At the National R e t a i l M e r c h a n t s A s s o c i a t i o n meeting in New York s o m e two weeks ago, P r o f e s s o r McNair of H a r v a r d , a leading m a r k e t i n g authority, f o r e c a s t a 4 - 1 / 2 p e r cent i n c r e a s e in national r e t a i l s a l e s in 1964, slightly l a r g e r than - 7 the increase in 1963. For the St. Louis and Alton area, knowledgable observers expect an improvement for 1964 of about the same s i z e . Regarding Federal R e s e r v e actions, we must remember that what we do is largely determined by the underlying performance of the economy. If further growth is maintained without the appearance of significant deterioration in either of the two critical and related areas of price stability and the b a l ance of payments, then monetary policy can continue to be expansive. On the other hand, although the last half of 1963 saw our balanceof-payments deficit improve, this improvement can be traced in large part to our higher short-term interest levels in the latter part of the year and to the effects of the interest-equalization tax. There are some indications that lowering of capital outflows by these two measures may not be lasting. On the other hand, the outlook for our balance of goods and s e r v i c e s and Government account does not look unfavorable. We shall have to be watchful of this problem as the year p a s s e s , particularly if foreign interest rates tend to r i s e and attract greater capital outflows. Again, we have been b l e s s e d with relatively few problems of inflation in the last few years, but should rising expenditure during 1964 be associated with renewed inflation, greater weight would n e c e s s a r i l y be given this problem in the formulation of policy. - 8 Finally, we must remember that the present upswing i s already one of the longest in the postwar era. Perhaps the pace will be continued, particularly so if the tax biU currently before Congress is passed, and i s stimulative. But there i s a possibility that the expansion might slacken, in which c a s e the usual Federal R e s e r v e action would be for more e a s e . These are just a few of the eventualities that we in the S y s t e m must bear in mind. Unfortunately, economics i s not an exact science, and we cannot predict the phases of the economy as the astronomers do the phases of the moon. Which is not to say that economists and policy makers are operating in the dark, but only that our experience suggests that policymaking is a matter of judgment, and that informed judgment, keeping in mind its limitations, i s better than uninformed judgment. but in our business it must be for the short run. day by day. The economy must be followed Fortunately monetary policy is highly flexible and can be changed promptly to meet existing n e e d s . Forecasting i s n e c e s s a r y ,
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