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November 1, 1974 Every Administration is necessarily restricted in its choice of programs by the uneven incidence of policy upon various sectors of the econ omy. It faces a difficult task ensuring that the burden of sacrifice is evenly distributed, so that policy may stay the course until the desired effects are achieved. The task is aggra vated by the special nature of to day's economic problem, with recession and inflation both oc curring simultaneously. Monetary policy tends to have a more uneven impact than fiscal policy. Sectors which rely heavily on credit flows— home-building in par ticular— usually bear the brunt of a tightening in monetary policy. Fiscal policy is better able to redistribute the burden of sacrifice, because tax and expenditure policies can be tailored to affect specific sectors of the economy, or to affect individ uals and businesses on the basis of their income through the income tax and the withholding mech anism. (As an example, the invest ment-tax credit can be used either to encourage or discourage plantequipment spending.) We should not try to impute too much preci sion to fiscal policy, but still, it generally has an advantage over monetary policy in this regard. For years, monetary policy has been forced to shoulder the major share of the burden of combatting infla tion. However, a restrictive mon etary policy sometimes is eased when unemployment worsens, be 1 fore the policy has had a chance to overcome the inflation it was de signed to contain. The basic prob lem, then, is to come up with a viable program that will minimize disparities in sacrifice so that an anti-inflation program may be fol lowed to its most effective limits. Monetary policy by itself cannot lessen these disparities; it governs the cost and availability of credit and leaves the allocation function to the market, which does not adjust for considerations of interpersonal equity. Fiscal package The Administration's fiscal program is centered largely around a $2.5billion income-tax surcharge, which would help pay the cost of an expanded public-employment pro gram and tax relief for lowerincome families. (The latter was not formally proposed in the Pres ident's message, but it is implicit in the Ways and Means Committee proposal for an increased low-in come allowance.) The employment program would encompass grantsin-aid to local governments to pro vide 400,000 to 700,000 jobs, depending on the level of unem ployment. Fiscal actions of this type, unlike monetary actions, can affect employment in a direct and precise fashion. The surcharge, despite its un doubted value as an anti-inflation tool, has been criticized as a pos sible contributor to recession. Real disposable income has declined 3.2 (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. percent over the past year, and real consumption spending has dropped by a comparable amount. The clas sical fiscal policy prescription for reducing aggregate demand thus seems ill-suited to what is no longer a demand-pull type of inflation. It should be remembered, however, that the entire fiscal package is de signed to have an essentially neu tral impact, since the extra revenues induced by the surcharge are al ready allocated under the program. In other words, the total package is meant to shift a given tax burden without either increasing or de creasing tax revenues. The Administration program would not only cushion the adverse distri butional effects of monetary policy through selective measures, but would also encompass a reduction in the level of government expendi tures. This reduction would not counteract the supportive measures already mentioned; it would simply mean a tighter ordering of priorities, with less pressing programs de ferred or abandoned. Reductions in defense hardware and construction, and deferrals of certain civilian pro grams (road construction, homeownership assistance and airport facilities) could provide savings of roughly $7 billion, and thereby per mit the budget to be brought be low the proposed $300-billion ceiling. With these cutbacks in spending and in the Federal deficit, the lessened demands upon the credit markets should be reflected 2 in lower interest rates, and conse quently in reduced pressure on monetary policy. Models of restraint Simulations performed with this bank's econometric model help illustrate what the Administration's program could accomplish, when coupled with a "stay the course" policy of moderate monetary re straint. For contrast, we can com pare this with the results obtained from a relatively easy policy aimed principally at the problems of re cession and unemployment. In the first simulation, which assumes a tight rein on Federal spending and a moderately restric tive monetary policy, significant progress would be made against inflation by the end of 1975, but at the cost of a slow turnaround in economic activity and growing unemployment. In the second simu lation, which assumes greater ease in both fiscal and monetary policy, progress against inflation would come more slowly, but definite improvement would occur by late 1975 in both real output and unemployment. Policy choice At first glance, the policy choice would strongly favor the relatively easy policy. However, this type of prescription could lead to future problems with inflation; after all, our present predicament is a legacy of too much ease in 1968 and again in 1972. The proper policy mix would appear to consist of one policy designed to overcome inflation and a second designed to make the anti-inflation fight reasonably equal in terms of social costs. Policymakers in the past have leaned heavily on mon etary policy in fighting inflation, but then have been forced to abandon the fight too soon because of the danger of recession. But with fiscal policy used judiciously to redistrib ute the burden of an anti-infla tionary program on a more equitable basis, it is possible to stay with such a policy until it achieves a more lasting effect upon inflation. There is no question that eliminat ing an inflation that was a decade in the making is definitely a long-haul problem. Yet the adverse distribu tional effects may be greatly mod ified through the use of a reasonable amount of ingenuity in formulating fiscal-policy measures. Herbert Runyon Western Highlights Business loan demand continued rising in September, especially in California. Mortgage loans turned sluggish, however, while security hold ings declined. Deposit flows weakened at Western banks during the month . . . Federal Reserve member banks reduced their borrowing at the San Francisco Bank's discount window in September by more than $30 million on a daily average basis. As another sign of decreased restraint, large bank purchases of Fed funds dropped sharply to their lowest point for the year. Employment increased slightly in the West during August, but lower California figures for September indicate that the regional increase may be shortlived. The August gains occurred in nearly all sectors, with a notice able increase in construction as workers returned to work after several strikes in the industry. . . . California's unemployment rate jumped from 7.7 to 8.2 percent in September, reflecting the worsening of the state's em ployment picture. This was in line with a jump in the national rate from 5.4 to 5.8 percent for the same time period. 3 m o u o } 8 u m s e / V \ • M e in • u o S a J O • e p e A S N • OLlB P I MEMBH • BjUJOpiB^ • E u o zu y *l!le3 'oaspuBJj ues ZSZ ON llWUHd aivd a o v is o d s n n v w s s v i d is a u BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Loans (gross) adjusted and investments* Loans gross adjusted— Securities loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other Securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Government deposits Time deposits— total* Savings Other time I.P.C. State and political subdivisions (Large negotiable CD's) Weekly Averages of Daily Figures Amount Outstanding 10/16/74 83,889 67,381 1,860 24,041 19,954 9,580 4,100 12,408 81,501 23,497 358 56,124 17,946 28,641 6,170 15, 111 Week ended 10/16/74 Change from 10/9/74 Change from year ago Dollar Percent - + 8,594 + 9,572 + 859 + 3,885 + 2,197 + 698 -1,313 + 335 + 7,678 + 1,625 - 237 + 6,017 + 259 + 5,546 + 88 + 3,566 897 724 — 770 — 28 + 42 + 19 43 — 130 + 647 + 589 + 65 - 138 + 30 — 85 — 64 — 165 Week ended 10/9/74 + + + + + + - + + + — + + + + + 11.41 16.56 85.81 19.27 12.37 7.86 24.26 2.77 10.40 7.43 39.83 12.01 1.46 24.01 1.45 30.89 Comparable year-ago period Member Bank Reserve Position Excess Reserves Borrowings Net free ( + ) / Net borrowed (—) 17r 63 46r 43 71 28 102 257 155 - + 1,175 + 760 -1 7 3 + 1,585 + 1,152 -2 3 0 - - Federal Funds— Seven Large Banks Interbank Federal fund transactions Net purchases ( + ) / Net sales (—) Transactions: U.S. securities dealers Net loans ( + ) / Net borrowings ( - ) ■"Includes items not shown separately. Information on this and other publications can be obtained by calling or writing the Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120. Phone (415) 397-1137. . E>|SB|y
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