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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)
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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
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GNP Deflator
Price Change
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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.
@FedFRASER