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April 17, 1973 MEETING WITH CHAIRMAN ARTHUR BURNS AND THE QUADRIAD Wednesday/ April 18, 1973 3:00 P.M. (120 min) The Oval Office S# ,r iiOHctJLil 3^ i>X'vFrom: George P. Shultz ,-/v % I. PURPOSE To discuss an appointment to the Federal Reserve Board, the economic outlook, and the future of the Economic Stabilization Program. H. m . BACKGROUND, PARTICIPANTS & PRESS PLAN A. Background: Chairman Burns requested a meeting with you to discuss an upcoming vacancy on the Federal Reserve Board and recent interest rate developments. (Secretary Shultz will sit in during this portion of the meeting). The other members of the Quadriad will then assemble for a discussion of the economic outlook and the future of the Economic Stabilization Program. B. Participants: Chairman Burns, Secretary Shultz, Director Ash, Chairman Stein. C. Press Plan: Meeting to be announced, TOPICS TO BE DISCUSSED 1. Upcoming vacancy on the Federal Reserve Board and the need to appoint a new Vice Chairman. See memo from George Shultz at Tab A. 2. Rundown on recent interest rate developments and the move to a dual prime rate structure. 3. Economic outlook. See memo from Herb Stein at Tab B. 4. General problem of inflation and the future of the Economic Stabilization Program. See memo from George Shultz at Tab C. T H E CHAIRMAN OF T H E CO U N CIL OF ECONO MIC ADV IS ER S WASHINGTON A p ril 17, 1973 MEMORANDUM FOR THE PRESIDENT Subject: Background for Quadriad M eeting of A pril 18, 1973 It now se em s clear that the m oney value of GNP r o se ex tra o rd i n a rily in the fir s t quarter - - at an annual rate of about 13%. This is about 30 p ercen t larger than we fo reca st at the beginning of the year. M ost of the e x c e s s is in p r ic e s, but the in c r e a se of r e a l output a lso su rp assed our fo r e c a st a little . This perform ance, coupled with other, even m ore sc a ry , evidence of risin g p r ic e s , p recip itates two qu estions. Is the econom y, as m easu red by the m oney GNP, risin g too rapidly? Should anything m ore be done to slow it down? % P robably the econom y would have been b etter off if GNP had not r isen so rapidly in the fir st quarter. We would probably a ls o be better off if it does not r is e so rapidly in the second quarter as it is lik ely to do. P r ic e p r e ssu r e s would have been le s s at a p articu larly se n sitiv e tim e -when the shift from Phase II to Phase III was being m ade, when the Stabilization A ct was up for extension, when food p r ice s and international p r ic e s w ere risin g rapidly anyway and when a lot of wage negotiations w ere in the offing. M oderation of the expansion would probably have had som e ad v erse effect on the unemployment rate, but that w as not the c r itic a l issu e at the tim e. The question whether anything m ore should be done to slow the expansion down is a different one. There is a gen eral b elief, which we sh are, that the expansion will- slow down at som e point to a rate which does not exceed our norm al growth rate. The question is whether steps to slow down the p resen t expansion would turn out in fact to d ep ress the econom y la ter when it wouldn't be too exuberant anyway. Or, the question is whether the chance of doing som e good in slow ing down the boom is worth the r isk of doing som e harm later in d ep ressin g the econom y. - 2 - The answ er to this question depends o n th e probable tim ing of the slowdown, if le ft alone, and on the probable tim ing of the e ffects of restrictive m ea su r es that m ay be availab le. T here is now a tendency for fo r e c a ste r s to defer the date of the p ro sp ectiv e slowdown, from around the m iddle of the year to around the end of the y ea r. This is partly b ecau se the fir s t quarter consum ption has been so strong that in ven tories could not be built up and the gen eral strength of the econom y m ay give an additional boost to investm en t. T here are two m ain candidates for action to curb the boom . One is g en eral m onetary p olicy. The other is tem p orary su sp en sion of the investm en t tax cred it, in whole or in part. The m onetary situation now looks quite different than it did at the beginning of the y ea r. There has been little in c r e a se of the m oney supply in 1973 w hile GNP has r ise n fa st. A s a resu lt'th e ratio of m oney supply to GNP is exceptionally low - - about 3 p ercen t le s s than a year ago. We cannot count on this ratio to fa ll - - o r v e lo c ity to r is e - - as fa st as this in the future. The rate of in crea se of the m oney supply in the past six m onths was about 5 - 1 / 2 percen t. Continuation of this rate should ex ert con sid erab le fo rce in bringing down.a rate of (j NP expansion which has been around 13 percent. On the other hand, it is probably unsafe to allow the rate of m onetary expansion to fa ll below the 5 to 6 percen t range for any sign ifican t period if we hope to le v e l out the rate of GNP expansion around 7 to 8 p ercent. Suspension of the investm ent tax cred it se e m s to m e a sa fer step, b ecau se it is w eaker on the downside. Suspension of the cred it would have som e sm a ll actual effect on expenditures for a period of six months or so , b ecau se of the backlog of o rd ers, but it m ay help to p reven t the boom psychology from becom ing exaggerated. R estoration of the cred it, if done b efore m uch slackening had occurred in the .economy, would probably a ffect spending m ore prom ptly, or at le a st so exp erien ce su g g ests. Thus it is p o ssib le to think of suspending the cred it, say, this Spring, and restorin g it in Novem ber and s till having a fa irly strong rate of in v est m ent going on in the Spring of 1974 and th erea fter. - 3 - D iscu ssion of econom ic p olicy at this tim e naturally r a is e s questions about next step s in p r ice -w a g e con trols. The su ggestion has been m ade that the A dm inistration should im pose a b rief, com prehensive fr e e z e . The argum ent against this se e m s to m e enorm ous, on p o litic a l and econom ic grounds, in the short run and in the long. As H eraclitus said, "You can not step into the sam e river tw ice, " and th is is certain ly not the sam e r iv er you stepped into on August 15, 1971. What does se em to m e relevant is p o ssib le tightening of P h ase III, along the follow ing lin es: a) R equire prenotification from large b u sin e sse s and unions for future in c r e a se s. b) T e ll the la rg e st com panies they cannot r a ise p r ice s until they have subm itted ju stification of the in c r e a se s they have m ade sin ce January 10. c) Change the perm itted p rice in c re a se from l.*5 p ercent a year to . 3 7 5 percent a quarter. Such action s would, how ever, be su p erifica l, both in their effects on p r ic e s and in their effects on public opinion. What seem s to m e m o st im portant, if we are out from under the shadow of a C on gression allydictated fr e e z e , is to explain our policy and the condition of the econom y as fo rcefu lly as p o ssib le . H erbert Stein
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