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April 21, 1978 No-WIN Situation? The WI N buttons were nowhere in evidence, but otherwise there were strong similarities last week to the Inflation Summit of late 1974, as opinion leaders throughout the country joined the President in the. call for an all-out war on inflation. Just as in 1974, there was an environment of high and accelerating inflation. Again, as in 1974, there were criticisms from all sides against the forces causing inflation including attacks on all the sacred cows that were peacefully grazing in somebody else's garden. But then as now, all agreed that the war against inflation could turn into a no-win situation unless everybody joined in the fray. The dissimilarities with the 1974 situation were just as striking - notably Wall Street's strong response to the anti-inflation clarion call. Consumer prices were rising at a 7.S-percent annual rate in early 1978, compared with the 12.1-percent rate of increase in late 1974. The economy remained strong in early 1978, whereas business conditions deteriorated rapidly in late 1974, in the midst of the sharpest recession of the past generation. To cite one obvious example, business balance sheets showed a strength early this year that was sadly lacking several years ago. Indeed, having learned from sad experience, business and government leaders this year seemed much more conscious than before of the need to choose policies that will restrain inflation without bringing recession in its wake. Turnaroundin statistics Then why the heavy concentration on the inflation issue at this time? Because the statistics indicated not only an acceleration of inflation, but also a strengthening of forces throughout the economy that could force prices to rise even faster. Consider the recent movement of the consumer-price index. Prices rose at a 7.S-percent annual rate in the latest three-month reporting period, reversing the deceleration of the summer and fall quarters of 1977, when the index rose at about a S.O-percent annual rate. Energy prices increased only modestly but food prices soared, rising at an 11.8-percent annual rate between November and February. Perhaps more importantly, prices of other commodities and services, which account for more than two-thirds of the entire consumer index, accelerated from a S.1-percent rate to·a 7.1percent rate over the latest threemonth period. Against that background, the latest Harris poll reported that the American public, by a margin of 82 to 10 percent, felt personally endangered more by inflation than by unemployment. food and energy What can we expect- for food, which accounts for less than one-fourth of the family marketbasket yet dominates dinner-table conversation throughout the land? Agriculture Department analysts had originally forecast a deceleration in food prices in 1978, following the sharp 8.0-percent increase recorded in 1977, when severe earlyyear weather conditions disrupted food production and distribution. But recently they raised their forecast, largely because of similar weather (continued on page 2) IT1 fu, cD) @lr'1 © h- 0 Opinions expressed in this newsletter do not necessarily reflect the views of t.he managementot the Federal ReserveBank of San Francisco, nor of the Board of Gcn/ernors of Hie Federal Reserve System. problems this past winter, but also because of downward revisions in estimated meat supplies. Still, price pressures could ease somewhat as normal conditions return on the supply line from farm to supermarket. If farmers' reported planting intentions are to be believed, the much-heralded farm strike has had almost no impact on production and hence on prices. However, farmer pressures on Congress could extend the gains they have already achieved through earlier legislation - a combination of production cutbacks and price guarantees which has ameliorated the farm recession yet contributed to consumer food-price increases. Farm prices should also rise this year because of an export recovery brought about by shortages overseas and a devaluation-caused decline in relative prices of U.s. farm products, but this too could lead to expanding pressures on U.s. supermarket prices. Energy prices, after a late-1977 period of stability, seem bound to rise in the aftermath of the coal strike, with its expensive new contract settlement. As for petroleum, policymakers still confront a serious dilemma - whether to live with a $4S-billion annual bill for imported oil, with its severe impact on the balance of payments, or to curb that inflow through costly government restrictions. These could include administrative quotas or fees if Congress fails to impose a crude-oil wellhead tax, but all such solutions would create at least short-term pressures on oil prices. The situation could be aggravated, of course, if the OPEC nations push for a rise in oil prices to compensate for the declining value of their dollar holdings. 2 Analysts of the cost-push variety point to the cost pressures arising in the production of non-food and non-energy commodities and services, which account for more than two-thirds of the consumer marketbasket. With labor productivity improving only modestly over the past year, substantial wage gains have been translated almost directly into higher costs and hence higher prices. And with consumer prices accelerating, the wage-price spiral could get another push - directly through the effect of wage escalators, which cover about three-fourths of all the major three-year labor contracts, or indirectly through rising demands for large first-year (front loaded) wage increases in upcoming negotiations. Few major contracts are being negotiated in 1978, but these contractsabove all, the hefty coal settlementcould set a pattern for the many major. contracts that will be coming up for renewal in 1979. Basic inflation problem Despite all these developments on an individual industry level, the basic answer to the problem of iilflation may have to be sought on the banks of the Potomac, for most price pressures may be traced to the vast expansion of Federal budget deficits, with the related pressure on the Federal Reserve to ensure the financing of those deficits. Indeed, much of the recent malaise, including the decline of the dollar overseas, could be traced to the highly inflationary implications of a substantial $53-billion deficit in the strong economic environment of fiscal 1978, followed by an even higher deficit of $60 billion or more in fiscal 1979. Measures now being considered by Congress could add $9 to $13 bil- --------lion more to spending levels, and to the deficit, in 1979. In addition, many market observers fear Washington's penchant for legislating more inflation through new legislation. Early this year,' the minimum wage rose 15 percent, the first stage of a mammoth social-security tax increase took hold, the price of steel rose under the umbrella of a ence price" system, and sugar and grain prices increased because of government agricultural-policy decisions. Further cost and price increases may result from recent or forthcoming government actions related to the coal settlement, energy policy, postal rates, and unemployment-insurance taxes. By some calculations, government actions of this sort may add a full percentage point or more to the basic rate of inflation. The recent news from the monetary front has been more encouraging, although market makers still fear that monetary policy will be pushed off course by the need to finance burgeoning Federal deficits. The money supply has recently grown at a decelerPercent ating pace; the broad M2measure has risen about 81/2 percent over the past four quarters, compared with an 1 1 -percent increase over the preceding year. (M2includes currency plus all bank deposits except large CD's.) Despite some acceleration in the underlying monetary base, M 2' s recent growth has held well within the Federal Reserve's announced target range, which suggests a lessened provision of inflationary tinder from the monetary side. Yet most signs continue to point to a . difficult struggle with inflation in the year ahead. Federal Reserve Chairman Miller recently commented on the need to concentrate on the inflation problem - the one component of the nation's economic strategy. As one means of doing so, President Carter last week pledged to ease fiscal pressures by, "if necessary, exercising my veto authority to keep the. 1979 budget deficit at or below the limits I have proposed." In the absence of measures of this sort, the 1970's may yet achieve the dubious distinction of being the most inflationary decade of the past century. William Burke 12 Consume\ "- 4 GNP Deflator Price Change 3 )/0\ . 8 uo:}8u!4SEM .. 4E:}n " uo8aJO .. EpEAaN oljEPI !!EMEH E!UJOJ!IE " EUOZlJV E>jSEIV J G y <!» \Ur\2? JJ em 'l!le:::> IOJSpueJ:I ueS ZSL 'ON llW1l3d Ol\"ld :l9\71 S0& 's'n @AJJ@<§@@ 1I1\7W SSVD lS'M1:I :{), BANKI NG DATA- TWELlFTH lFlEDlElRALlRlESlElRVIECT DISTRI (Dollar amounts in millions) Amount Outstanding 4/5178 Loans (gross, adjusted) and investments* Loans (gross, adjusted)- total Security 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* States and political subdivisions Savingsdeposits Other time deposits+ Large negotiable CD's 109,440 86,847 2,676 26,396 28,971 15,236 8,096 14,497 107,639 30,643 597 74,391 6,355 32,066 33,357 15,167 + 873 + 1,444 + 806 + 189 + 146 65 + - 614 43 + + 498 Weekly Averages of Daily figures Week ended 4/5178 Change from year ago Dollar Percent Change from 3129178 Selected Assets and liabilities large Commercial Banks Member Bank Reserve Position ExcessReserves(+)/Deficiency (-) Borrowings Net free(+)/Net borrowed (-) federal funds-Seven large Banks Interbank Federalfund transactions Net purchases(+)/Net sales(-) Transactionswith U.S. security dealers Net loans (+)/Net borrowings (-) + + + + 103 15 88 332 467 + + - + - - 1,009 49 914 42 48 679 724 + 11,596 + 1"2,609 766 + 2,904 + 6,486 + 2,780 2,571 + 1,558 + 11,041 + 2,233 109 + + 8,508 + 1,172 230 + 7,218 + 5,479 + - + + + - Week ended 3129178 + + + 14 31 17 508 374 - + + + + + + - + + 11.85 16.98 22.25 12.36 28.85 22.32 24.10 12.04 11.43 7.86 22.34 12.91 22.61 0.71 27.61 56.55 Comparable year-ago period + + + + 27 1 26 49 280 *Includes items not shown separately. tlndividuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author . . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San.Francisco,P. O. Box 7702, San francisco 94120. Phone (415) 544-2184.