Full text of Monetary Policy Oversight : House of Representatives Hearings : Conduct of Monetary Policy (Pursuant to the Full Employment and Balanced Growth Act of 1978, P.L. 95-523) : Hearings Before the Committee on Banking, Finance and Urban Affairs, House of Representatives, Ninety-Seventh Congress, Second Session, February 10 and March 30, 1982

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CONDUCT OF MONETARY POLICY
((Pursuant to the Full Employment and Balanced Growth
Act of 1978, P.L. 95-523)

HEARINGS
BEFORE THE

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES

NINETY-SEVENTH CONGRESS
SECOND SESSION
FEBRUARY 10 AND MARCH 30, 1982

Serial No. 97-57
Printed for the use of the
Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1982

HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST GERMAIN, Rhode Island, Chairman
HENRY S. REUSS, Wisconsin
J. WILLIAM STANTON, Ohio
HENRY B. GONZALEZ, Texas
CHALMERS P. WYLIE, Ohio
STEWART B. McKINNEY, Connecticut
JOSEPH G. MINISH, New Jersey
GEORGE HANSEN, Idaho
FRANK ANNUNZIO, Illinois
PARREN J. MITCHELL, Maryland
JIM LEACH, Iowa
WALTER E. FAUNTROY, District of
THOMAS B. EVANS, JR., Delaware
RON PAUL, Texas
Columbia
STEPHEN L. NEAL, North Carolina
ED BETHUNE, Arkansas
JERRY M. PATTERSON, California
NORMAN D. SHUMWAY, California
JAMES J. BLANCHARD, Michigan
STAN PARRIS, Virginia
CARROLL HUBBARD, JR., Kentucky
ED WEBER, Ohio
JOHN J. LAFALCE, New York
BILL McCOLLUM, Florida
DAVID W. EVANS, Indiana
GREGORY W. CARMAN, New York
GEORGE C. WORTLEY, New York
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
MARGE ROUKEMA, New Jersey
MARY ROSE OAKAR, Ohio
BILL LOWERY, California
JIM MATTOX, Texas
JAMES K. COYNE, Pennsylvania
BRUCE F. VENTO, Minnesota
DOUGLAS K. BEREUTER, Nebraska
DOUG BARNARD, JR., Georgia
DAVID DREIER, Calif.
ROBERT GARCIA, New York
MIKE LOWRY, Washington
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland

CONTENTS
Hearings held on—
February 10, 1982
March 30, 1982

Page
1
113
STATEMENTS

Regan, Hon. Donald T., Secretary of the Treasury
Schultz, Hon. Frederick H. Vice Chairman, Board of Governors, Federal
Reserve System
Volcker, Hon. Paul A., Chairman, Board of Governors, Federal Reserve
System
Wright, Hon. Jim, a Representative in Congress from the State of Texas and
majority leader of the House of Representatives

127
11
11
113

ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION iff THE RECORD
Fauntroy, Hon. Walter E., chairman, Subcommittee on Domestic Monetary
Policy, opening statement
9
Regan, Hon. Donald T.:
Prepared statement
133
Response to information requested by the following Congressmen:
Hon. BillPatman
195
Hon. Henry S. Reuss
174
Hon. Charles E. Schumer
193, 194
Stanton, Hon. J. William, opening statement
4
United Automobile Workers International Union (UAW), letter from Sheldon
Friedman, research director, dated April 5, 1982
204
Volcker Hon. Paul A.:
"Monetary Policy Report to Congress Pursuant to the Full Employment
and Balanced Growth Act of 1978"
24
Attached to statement:
Chart—Growth Ranges for and Behavior of Ml, 1981 and 1982
22, 23
Table 1.—Monetary Growth 1981
20
Table 2.—Growth of Money and Bank Credit (percentage changes)
20
Table 3.—Monetary Growth Targets 1982
21
Response to information requested by Congressman Bill Lowery
87, 90
Vollmers, Vere, vice president, Minnesota Farmers Union, statement
199
(in)

CONDUCT OF MONETARY POLICY
WEDNESDAY, FEBRUARY 10, 1982

HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met, pursuant to notice, at 10:05 a.m., in room
2128 Rayburn House Office Building; Hon. Fernand J. St Germain
(chairman of the committee) presiding.
Present: Representatives St Germain, Reuss, Gonzalez, Minish,
Mitchell, Fauntroy, Neal, Patterson, LaFalce, D'Amours, Lundine,
Oakar, Mattox, Vento, Barnard, Schumer, Frank, Patman, W.
Coyne, Hoyer, Stanton, Wylie, Hansen, Leach, Evans of Delaware,
Paul, Bethune, Shumway, Parris, McCollum, Carman, Wortley,
Roukema, Lowery, J. Coyne, and Dreier.
The CHAIRMAN. The committee will come to order.
Never in its 69-year history has the Federal Reserve been the
subject of so much sustained attention in the executive branch as it
is today. With the possible exception of the National Security Adviser, it seems from the rank of Assistant Secretary up has had a
few words of advice for Paul Volcker during the past few months,
not, of course, that all the words have been the same.
On Mondays, Wednesdays, and Fridays, the Federal Reserve can
do nothing right in the eyes of the administration. On Tuesdays
and Thursdays the spokesmen trot out with olive branches and pronounce the Federal Reserve a full-fledged, card-carrying member of
the supply side squad. On Sundays the administration's economic
experts explain away the week's confusion on "Meet the Press/'
"Face the Nation," and the other assortment of interview shows.
For the markets, the public and Congress, it is a confusing spectacle of "he loves me, he loves me not," hardly an inspiring sight.
If Paul Volcker received strange signals from the administration
during 1981, he was not alone. A year ago we were being bedazzled
by Laffer curves, Stockman pronouncements and assurances that
supply side prosperity was coming around the corner at breakneck
speed.
Somewhere along the route to wonderland, the supply side vehicle hit some mammoth potholes, blew its tires, and it sits there
today on the side street waiting for the Stockman tow service.
The result of the journey on the supply side has been the longest
sustained period of back-breaking high interest rates, the longest
lines of unemployed in the post-World War II period, skyrocketing
business bankruptcies, and growing examples of human misery
from coast to coast.
(l)

After the economic body of the Nation has be*n bled for a year
by medieval doctors who populate the supply side shrines, one
would think that a prudent man would seek a new course, a new
set of policies, if not a new staff of doctors. But, no. The new
budget is released and the answer is "If you disliked 1981, you will
truly loathe 1982."
The fiscal year 1982 budget is constructed on a swamp of economic projections supported by no one outside the administration's
immediate family—cuts in essential social programs that aren't
going to be voted, interest rate estimates that are more hopeful
than real, economic growth that is seen nowhere on the horizon,
and pie-in-the-sky revenue sources that no one takes seriously. All
this so the administration can avoid admitting to the American
public that we face a deficit well over $100 billion.
We can all wait for the summer editions of Atlantic Monthly to
hear the true confessions.
Budget documents that vie for fiction awards don't change reality. The Nation is in deep trouble. This committee—over the protest
of some—went into the field last year to learn of conditions firsthand. Human misery has been growing. The despair is there and it
is despair— fear—that cuts across social, economic and political
lanes. Let there be no mistake about it. We have seen it up close.
I am genuinely happy that the President has decided to follow
this example and go into the countryside himself. He won't get the
picture at the Republican fundraisers, but if his inner circle will let
him out among the people, he will learn that while he may be liked
as a person, his programs and policies are generating nothing but
fear among the hardworking Americans who make up the core of
this Nation.
While I sympathize with the Federal Reserve efforts to read the
confused signals of this administration, it would, indeed, be simplistic—and inaccurate—to absolve the monetary policy machinery
from blame.
While Paul Volcker conducts himself with a high degree of class
compared to the administration's Keystone Kop search for scapegoats, the policies of the Federal Reserve have not, for the most
part, deviated from those of the administration.
There is growing concern about the inability of the Federal Reserve to hit targets and its consistent preoccupation with the lower
reaches of targets for the basic money supply. I do not believe that
the Federal Reserve, its protestations to the contrary notwithstanding, fully understands how devastating high interest rates are to
the people of this Nation. There is a certain splendid isolation in
this agency that prevents it from feeling the vibes of the worker,
the small businessman, the homebuyer, the communities struggling
to survive in a sea of high interest rates.
Both the administration and the Federal Reserve point with
pride to lower inflation rates. Nothing warms the inner soul of the
Federal Reserve more than its holy war against inflation. This is
all well and good. No one on either side of the aisle can lay exclusive claim to their distaste for double digit inflation.
But let me remind both the administration and the Federal Reserve that in 1933 this Nation had indeed wrung inflation from the
economy.

In the face of rising unemployment, some of the sideline cheers
for lower inflation rates suggest that some feel that there's nothing
that ails this country that a good old-fashioned Hoover-style depression wouldn't cure. Let us hope that this is not where the administration and the Federal Reserve are leading us.
Now, Mr. Chairman, we welcome you to our committee with
open arms and, as you summarize your statement, I would ask you
to give thought to the following two questions and respond to them
at the conclusion of your summary.
No. 1, when you appeared before this committee last July, the
Federal Reserve's open market committee predicted
that the unemployment rate in 1981 would be between ll/2 and 8V4 percent. As
you know, the actual rate in 1981 was 8.3 percent, above the Federal Open Market Committee's forecast. Now
the FOMC is predicting
unemployment in 1982 will be between 81A and 9 1 /2 percent. Does
this mean that we can expect unemployment to be approximately
10 percent in 1982?
And last year we were never certain where the Fed stood on the
administration's great experiment in supply side economics. Clearly the administration's budget, tax policy and approach to the economy bears directly on your duties and the success or failure of
monetary policy. I would like to know, as specifically as possible,
just how realistic you feel the administration's 1982 economic
policy is and how well you believe it meets the real needs of the
Nation.
Frankly, we need to know your opinion now, rather than 12
months down the trail, when secondguessing will become rather
epidemic, as it has just recently.
I would like to end on a pleasant note, and state that it is good to
see Mr. Schultz with us this morning. I understand that this afternoon he will attend his last Federal Reserve Board meeting and
subsequently he will retire to warmer climes. I want to thank him,
on behalf of all the members of this committee, for his service to
the Republic.
I know these have been hard times for you, but you have served
well. We certainly appreciate the fact that you gave of your time
during this very difficult period.
Mr. Stanton?
Mr. STANTON. Thank you very much, Mr. Chairman. I do have a
prepared statement, Mr. Chairman, that I would like to issue at
this time for the record, and make a few extemporaneous remarks.
[Mr. Stanton's opening statement follows:]

OPENING STATEMENT OF HON, J, WILLIAM ST/WTON
HEARINGS ON THE CONDUCT OF ITOETARY POLICY
FEBRUARY 10, 1982
MR, CHAIfmN I WOULD LIKE TO JOIN YOU IN WELCOMING OUR DISTINGUISHED WITNESS, CHAIRMAN
VOLCKER, WHO IS HERE TO FULFILL THE REQUIREMENTS OF THE HUMPHREY-HAWKINS ACT OF

1978,
I BELIEVE HE HAS REASON TO'-BE SATISFIED WITH THE PROGRESS THAT HAS BEEN MADE
IN FIGHTING INFLATION SINCE HIS PREVIOUS TESTIMONY LAST JULY,
DESPITE THE CURRENT RECESSION AND THE ASSOCIATED POSTWAR HIGH LEVEL OF UNEMPLOYMENT, INFLATIONARY EXPECTATIONS HAVE CALMED AND THERE IS SOME EVIDENCE THAT
THE UNDERLYING TREND OF COSTS IS SLOWING, LOOK AT INFLATION AS MEASURED BY ANNUAL
CHANGES OF THE CPI IN RECENT YEARS, SlNCE 1978 IT DECLINED AS FOLLOWS:
19

"80

12,6

(ESTIMATED BY THE ADMINISTRATION)
(ESTIMATED BY THE ADMINISTRATION)
THIS RECORD OF PROGRESS SHOULD BE CONSIDERED IN THE CONTEXT OF THE SOCIAL COST OF
INFLATION, LAST JULY, TREASURY UNDER SECRETARY SPRINKLE OUTLINED THE RAVAGES OF
INFLATION FOR THIS COMMITTEE IN THESE TERMS, ASSUME, FOR EXAMPLE, A 10% INFLATION
RATE FOR THE NEXT 20 YEARS:
-- THE $3,35 MINIMUM WAGE WOULD HAVE TO RISE TO
$22,50 TO MAINTAIN ITS PURCHASING POWER;
~ A $1,000 COLLEGE TUITION WOULD SOAR TO $6,700j

— A $50,000 HOUSE WOULD INCREASE IN PRICE TO $336,000;
— AN EXPECTED RETIREMENT INCOME OF $20,000 WOULD DECLINE IN PURCHASING POWER TO $3,000,
ALTHOUGH THERE ARE DIFFERENCES OF OPINION ON THE OPERATING TECHNIQUES OF MONETARY POLICY, THE ADMINISTRATION AND THE FEDERAL RESERVE ARE IN GENERAL AGREEMENT
THE NEED TO ACHIEVE AND MAINTAIN STABLE, NONINFLATIONARY MONEY GROWTH, IN

HIS 1983 BUDGET MESSAGE, THE PRESIDENT NOTED THAT ",, ,THE FEDERAL RESERVE HAS TAKEN
ACTION TO BRING EXCESSIVE MONEY GROWTH UNDER CONTROL,,,THE EXCESSIVE, UNSUSTAINABLE,
AND EVENTUALLY RUINOUS GROWTH OF MONEY AND CREDIT OF THE PAST DECADE HAS BEEN
CURBED,"

IN ASSESSING AVAILABLE MONETARY POLICY OPTIONS WE MUST KEEP IN MIND THAT
FASTER MONEY GROWTH CAUSES INTEREST RATES TO GO UP, NOT DOWN, FINANCIAL MARKETS
VIEW RAPID MONEY GROWTH AS A SIGNAL THAT THE FEDERAL RESERVE IS EASING ITS POLICY
AND WILLING TO ACCOMODATE MORE INFLATION; HENCE, THEY MUST DEMAND HIGHER INTEREST
RATES BECAUSE OF THE INFLATION PREMIUM, THOSE WHO CALL FOR FASTER MONEY GROWTH NO MATTER HOW WELL INTENTIONED - WOULD ONLY WORSEN THE TWIN PROBLEMS OF HARNESSING
INFLATIONARY EXPECTATIONS AND HOW TO LOWER INTEREST RATES,
ACCORDINGLY, WE MUST CONTINUE TO DECELERATE MONEY GROWTH, A STRATEGY TO WHICH
THIS ComiTTEE HAS SUBSCRIBED IN THE PAST, THE NEW Ml TARGET RANGES FOR 1982
APPEAR WELL SUITED TO THIS PURPOSE,

LOOKING BACK, PROGRESS WAS MADE LAST YEAR IN

REDUCING MONEY GROWTH AND ESTABLISHING THE FOUNDATION FOR SUSTAINABLE, NONINFLATIONARY
ECONOMIC GROWTH,

IN 1981,

Ml GREW AT A 5,0% RATE, BELOW THE TARGET RANGE OF 6,0%

TO 8,5%,
ERRATIC SWINGS IN MONEY GROWTH, HOWEVER,. HAVE CONTRIBUTED TO THE UNEASINESS
OF THE MONEY AND CAPITAL MARKETS, FROM JANUARY THROUGH APRIL OF 1981, Ml GREW AT
A RATE OF ABOUT 14%, THIS PERIOD OF RAPID EXPANSION WAS FOLLOWED BY A SIX-MONTH
PERIOD OF NO MONEY GROWTH,

MONEY THEN INCREASED AT A 13% RATE DURING THE LAST TWO

MONTHS OF 1981, SINCE NOVEMBER OF 1981, Ml HAS GROWN AT AN APPROXIMATE RATE OF
17%, WELL ABOVE THE 1982 TARGET RANGE, THIS RECENT, RAPID GROWTH COULD CREATE
PROBLEMS IN 1982 IF NOT CAREFULLY HANDLED,
IF WE ARE SERIOUS ABOUT REAL ECONOMIC GROWTH AND STRIVING FOR FULL EMPLOYMENT,
THE FEDERAL RESERVE MUST PERSIST IN ITS LONG RANGE EFFORTS TO BRING THE GROWTH OF
THE MONEY SUPPLY TO AN ACCEPTABLE, NON INFLATIONARY LEVEL, THIS IS THE ONLY WAY IN
WHICH THE BURDEN OF HIGH INTEREST RATES CAN BE LIFTED OFF THE SHOULDERS OF
INDIVIDUAL HOUSEHOLDERS AND CREDIT-SENSITIVE BUSINESS FIRMS, STATE AND LOCAL
GOVERNMENTS AND CHARITABLE INSTITUTIONS, THIS IS THE ONLY WAY TO REVIVE LONGTERM CAPITAL INVESTMENTS TO MAKE AMERICA'S SHOPS, FARMS AND MINES MORE PRODUCTIVE,
As FORMER FEDERAL RESERVE CHAIRMAN ARTHUR BURNS HAS NOTED, THE ANGUISH OF
CENTRAL BANKING ARISES NOT SO MUCH FROM THE INABILITY TO CONTROL MONEY GROWTH, BUT
RATHER FROM THE DIFFICULTIES THAT CENTRAL BANKERS HAVE IN OVERCOMING THE POLITICAL
PRESSURES ASSOCIATED WITH MONEY RESTRAINT, WlTH THIS THOUGHT IN MIND, WE LOOK FORWARD
TO YOUR TESTIMONY TODAY,

Mr. STANTON. First, I join you in recognizing the presence here
today of the Vice Chairman—the former Vice Chairman of the
Board, Fred Schultz. Mr. Vice Chairman, we asked specifically that
you come this morning so that we could personally and publicly
thank you for the services that you have rendered to the Board and
to its Chairman over the last 2% years.
I specifically wanted to do this because, truthfully, back in the
Carter administration we viewed your original announcement at
that time with a little question. I remember you were serving, I
think, as Speaker of the State legislature on a partisan basis in the
State of Florida and so forth, and you were a good banker. But let
me tell you that any doubts I had are long gone because you performed eloquently, in my opinion, and you have proved to be a
great public servant. I want to personally join the Chairman in
thanking you.
Second, Vice Chairman Schultz, your appearance here this morning reminds me more, really, of the independence of the Federal
Reserve System that the Chairman alluded to. I say your appearance does because the Chairman, Paul Volcker, needs nobody to
back him up. Like his predecessors, William McChesney Martin,
and Arthur Burns, he really doesn't need anybody to defend him.
You do emphasize that the Federal Reserve Board is something
that I have always been taught, since the days of Wright Patman,
is an instrument of Congress and, as such, created by Congress.
You are subject to Congress in that regard. I don't remember a
year that we haven't had legislation introduced that is the result of
high interest rates. What would they call it? The reorganization of
the Federal Reserve Board or the reorganization of the Federal Reserve Act. Every year we have some legislation that comes along
and goes nowhere.
I do want to emphasize that in my opinion it is regrettable that
the administration, has gone public in its criticism. Everyone is entitled to do it, but my constituents back home don't really know
the difference between the administration, Congress, and the Federal Reserve System. And when you see one picking on the other I
just don't think it enhances any one position.
And as for those who may call for the resignation of the Chairman of the Federal Reserve System, let me say that everyone is entitled to their opinion, but it always reminds me of somebody who
is used to the offense and when that is not going too well they
claim the defense or somebody else is to blame.
Finally, Mr. Chairman—and we will get into the details here this
morning quickly with regard to the responsibility that the Fed has
to us and that we have to them—there will be hard questions that
have to be asked and should certainly be asked.
But in conclusion let me simply add that this independence of
the Federal Reserve System is something that we will preserve.
There will be no changes, I would hope, in the makeup of the Federal Reserve Board itself with regard to the way it is constituted at
the present time, so that anything else discussed specifically is
sheer talk. It may be good for public consumption, but in reality it
will never happen.
Thank you.

The CHAIRMAN. Thank you, Mr. Stanton. The Chair has received
a request from the chairman of the subcommittee with jurisdiction
over the Federal Reserve Board to make an opening statement.
The Chair at this time recognizes Mr. Fauntroy.
Mr. FAUNTROY. These hearings on the conduct of monetary
policy are being held at a time of deep economic distress. Unemployment rates were at 8.9 percent in December of last year and
will, without doubt, be even higher when the February unemployment figures are released. That is the highest rate since the last
Republican recession, that of 1974-75. Unemployment has hit hardest at our young people and at our minorities. In December, 21.7
percent of the teenagers in the work force were unemployed, as
were 13.7 percent of those between 20 and 24 years of age. Among
minorities, 40 percent of all teenagers were unemployed and 15.1
percent of minority adult males were without jobs. Think about
that—nearly 1 out of every 10 Americans who want jobs can't find
them. More than 1 out of every 8 young adults and 1 out of every 7
minority Americans who want jobs cannot find them. Almost half
of all black teenagers are out of work. Think about the psychological damage to individuals and to families. Think about the social
consequences of broken homes and increased crime from that unemployment, and think about the personal despair and even suicides that result.
Then think about the broken promises of this administration.
Think about the broken promise of supply-side economics that
there would be an upsurge in prosperity and economic activity and
employment if we just cut tax rates. Think about the broken promise of the social safety net after this administration reduced unemployment benefits and cut food stamps and cut welfare benefits and
cut medicaid, and now is proposing even more reductions. Think
about this administration's promise that the monetarist's cure for
inflation would only cause, according to Treasury Under Secretary
Beryl Sprinkel, "a relatively short period of * * * pain." Think
about this administration's broken promise of a balanced budget,
when the deficits currently projected over the next few years will
add as much to the national debt as has been accumulated over the
previous 200 years.
All we hear from the administration are excuses and vague
hopes. The administration denies that it is responsible for the current recession and high unemployment while at the same time
claims credit for the reduction in inflation. Yet the total employment is now half a million lower than a year ago and half of the
drop in the CPI from its 1980 peak occurred during this administration's period of office. This administration points to the job listing in the Washington Post as a sign that there are jobs available,
while at the same time it cuts funds for job training and education
that would provide people with the skills needed for those jobs.
This administration blithely denies that its future deficits have
anything to do with the high interest rates we have been experiencing, blaming those high interest rates on volatility in the Federal Reserve's control of the money supply. This administration still
insists that everything will work out in the future, despite the fact
that its initial predictions for the economic growth—for interest
rates, for deficits, and for employment—have so far been all wrong.

The key economic problem that we face today, I think we can all
agree, is high interest rates. It was high interest rates last summer
that caused our current recession and high unemployment. It is a
resurgence of high interest rates over the past 2 months that will
stand in the way of recovery and it is the likelihood of a recurrence
of high interest rates later this year that may well lead to yet another Republican recession in 1983. So the key question we must
address in these hearings today is why interest rates are high.
I think we know the reason interest rates are high. They are
high because there is no confidence by the marketplace in the programs of this administration. One can debate the precise role
which the Federal Reserve might play in how tight or loose the
money supply ought to be, or even whether or not the Federal Reserve is using the best methodology to control the money supply.
But these issues are peripheral to the fundamental falacies of this
administration's economic policies of cutting taxes for the rich, cutting aid to the poor and working people, spending money on defense like a drunken sailor and then pretending that the resulting
deficits do not matter if the Federal Reserve would just tighten up
the money supply.
We need to face the fact that this administration has no plan for
reducing interest rates other than to blame the Federal Reserve.
Essentially, they have argued that it is the volatile money supply
which has led to the adoption of uncertainty premiums, in addition
to inflation premiums. This is a most novel and fatuous argument.
Administration officials fully know that there is no relationship between the short-run fluctuations of the money supply and inflation
or to much of anything else that affects the interest rates. It is as
disingenuous as their claim that they deserve credit for the lower
inflation, but not the blame for the high unemployment.
The inescapable facts are that it is the prospect of large and
growing deficits that produced high interest rates last year and
that this administration has no credible plan for reducing those
deficits. Look at the numbers. Under last year's tax rates, Federal
revenues were reduced to 19 percent of GNP by 1984. Under current plans, spending for defense will equal 6 percent of GNP, social
security, medicare, and retirement benefits alone will equal 7 percent of GNP, and interest payments will be close to 3 percent of
GNP. That will leave only 3 percent of GNP to be spent on every
other Federal program, from aid to the poor, highways, the FBI,
the State Department, to the Congress, and the White House. Not
only is that less than the 7 percent of GNP spent on these functions in 1981, it is less than the 6.6 percent of GNP spent in 1970 or
even less than the 5.5 percent of GNP spent in 1960 at the end of
the Eisenhower administration. No wonder this administration has
decided that deficits are not so bad after all, and no wonder that
the financial markets are so skeptical of this administration's policies. The only hope that the administration has is that there will
be a rapid economic growth. But how can that take place when
enormous deficits are projected that are driving interest rates up at
an alarming pace?
The administration's deficit-prone fiscal policy places the Federal
Reserve in a difficult position. Because this administration has no
other policy for reducing inflation, if the Federal Reserve eases its

monetary policy to relieve the deficits in pressure on credit markets, that would set off fears of more inflation and drive up the inflation premium in interest rates.
I ask unanimous consent to allow me to continue for 1 minute.
The CHAIRMAN. All right. The Chair would like to hear from Mr.
Volcker at some point. [Laughter.]
Mr. STANTON. I hope the chairman will take that in mind in his
remarks.
Mr. FAUNTROY. All right. I will yield to the suggestion of the distinguished ranking minority member on that and simply ask that
the rest of my statement be included in the record for reading by
all Members.
[The full text of Mr. Fauntroy's opening statement follows:]
REMARKS OF HON. WALTER E. FAUNTROY, CHAIRMAN, SUBCOMMITTEE ON DOMESTIC
MONETARY POLICY
These hearings on the conduct of monetary policy are being held at a time of deep
economic distress. Unemployment rates were at 8.9 percent in December of last
year, and will without doubt be even higher when the February unemployment figures are released. That is the highest rate since the last Republican recession, that
of 1974-1975. Unemployment has hit hardest at our young people and at our minorities. In December, 21.7 percent of the teenagers in the work force were unemployed, as were 13.7 percent of those between 20 and 24 years of age. Among minorities, 40 percent of all teenagers were unemployed, and 15.1 percent of minority
adult males were without jobs. Think about that—nearly one out of every ten
Americans who want a job are without one. More than one of every eight young
adults, and one of every seven minority Americans, who want a job cannot find one.
Almost half of all black teenagers are out of work. Think about the psychological
damage to individuals and to families, think about the social consequences of broken
homes and increased crime from that unemployment, and think about the personal
despair and even suicides that result.
Then, think about the broken promises of this Administration. Think about the
broken promise of supply-side economics, that there would be an immediate upsurge
in prosperity, in economic activity and employment if we cut tax rates. Think about
the broken promise of the social safety net, after this Administration reduced unemployment benefits, cut food stamps, cut welfare benefits, cut medicaid, and is now
proposing even more reductions. Think about this Administration's promise that the
monetarist's cure for inflation would only cause, according to Treasury Undersecretary Beryl Sprinkel, "a relatively short period of ... pain." Think about this Administration's broken promise of a balanced budget, when the deficits currently projected over the next few years will add as much to the national debt as had accumulated over the previous two hundred years.
All we hear from the Administration are excuses and vague hopes. The Administration denies that it is responsible for the current recession and high unemployment, while at the same time it claims credit for the reduction in inflation. Yet,
total employment now is half a million lower than a year ago, and half of the drop
in the CPI from its 1980 peak occurred before this Administration took office. This
Administration points to the job listings in the Washington Post as a sign that there
are jobs available, while at the same time it cuts funds for job training and education that would provide people with the skills needed for those jobs. This Administration blithely denies that its future deficits have anything to do with the high interest rates we have been experiencing, blaming those high rates on volatility in the
Federal Reserve's control of the money supply. And this Administration still insists
that everything will work out in the future, despite the fact that its initial predictions for the economic growth—for interest rates, for deficits, and for employment—
have so far all been wrong.
The key economic problem that we face today, I think we can all agree, is high
interest rates. It is high interest rates last summer that caused our current recession and high unemployment. It is a resurgence of high interest rates over the past
two months that will stand in the way of recovery, and it is the likelihood of a recurrence of high interest rates later this year that may well lead to yet another Republican recession in 1983. So, the key question we must address in these hearings
today is why interest rates are high.

10
I think we know the reason interest rates are high. They are high because there
is no confidence by the market place in the programs of this Administration. One
can debate the precise role which the Federal Reserve might play in how tight or
loose the money supply ought to be, or even whether or not tjie Federal Reserve is
using the best methodology to control the money supply. But, these issues are peripheral to the fundamental fallacies in this Administration's economic policies of
cutting taxes for the rich, cutting aid to the poor and working people, spending
money on defense like a drunken sailor, and then pretending that the resulting deficits don't matter if the Federal Reserve would do things right.
We need to face the fact that this Administration has no plan for reducing interest rates other than to blame the Federal Reserve. Essentially, they have argued
that it is the volatile money supply which has led to the adoption of "uncertainty
premiums" in addition to the inflation premiums. This is a most novel and fatuous
argument. Administration officials know full well that there is no relationship between the short run fluctuations of the money supply and inflation, or to much of
anything else that affects interest rates. It is as disingenuous as their claim that
they deserve credit for lower inflation, but not blame for higher unemployment.
The inescapable facts are that it is the prospect of large and growing deficits that
produced high interest rates last year, and that this Administration has no crediable plan for reducing those deficits. Look at the numbers! Under last year's tax
cuts, Federal revenues will be reduced to 19 percent of GNP by 1984. Under current
plans, spending for defense will equal 6 percent of GNP, Social Security, Medicare,
and retirement benefits alone will equal 7 percent of GNP, and interest payments
will be close to 3 percent of GNP. That will leave only 3 percent of GNP to be spent
on every other Federal program, from aid to the poor, highways, the FBI, the State
Department, to Congress and the White House. Not only is that less than the 7 percent of GNP spent in these functions in 1981, it is less than the 6.6 percent of GNP
spent in 1970, or even less than the 5.5 percent of GNP spent in 1960 at the end of
the Eisenhower Administration. No wonder that this Administration has decided
that deficits are not so bad after all, and no wonder that the financial markets are
so skeptical of this Administration's policies. The only hope that the Administration
has is that there will be rapid economic growth, but how can that take place when
enormous deficits drive up interest rates or absorb all the new savings that may
occur?
The Administration's deficit-prone fiscal policy places the Federal Reserve in a
difficult position. Because this Administration has no other policy for reducing inflation, if the Federal Reserve eases its monetary policy to relieve the deficits' pressure
on credit markets, that would set off fears of more inflation and drive up the inflation premium in interest rates. But if the Fed tightens monetary policy to maintain
anti-inflation credibility, that will make credit conditions even tighter and lead to
even more unemployment. However, the course that the Fed has announced today
is not an acceptable way out of that dilemma. Almost every economic forecast I
have seen assumes a money-growth rate of close to 6 percent if there is to be a sustained recovery this year. That rate is within last year's target range for M-l. But if
the targets are lowered, as the Fed has now proposed, these same forecasts suggest
that there will be a prolonged recession, a weak recovery, and yet another recession
in 1983. I think the Fed could have given the economy a little more breathing room
and reduced a little bit the adverse consequences of this Administration's fiscal policies it had retained last year's targets for monetary growth. Still, I recognize that
there are difficulties in controlling money supply with precision, because of the increasing blurring of boundaries between transaction and savings balances. For this
reason, the Subcommittee on Domestic Monetary Policy will hold hearings on
March 3 and 4 on the impact of money substitutes on monetary control.
But that being said, there can be no question that any major solution to our economic problems will have to come from this Administration, and from changes in its
economic policies. As that noted Republican and conservative Herbert Stein has said
of the Administration's program, "When the captain of the cruise ship leaves New
York harbor to sail north to Bermuda, one does not have to wait until ice bergs are
spotted to call for a change of course."

Mr. PATMAN. Mandatory reading. [Laughter.]
Mr. FAUNTROY. Yes, mandatory reading. Let me conclude, Mr.
Chairman, by echoing your words of praise for retiring Vice Chairman Schultz, who has brought an unusual dedication to his tenure
on the Federal Reserve Board, who by his careful attention to
detail and close working relationship of the staff of the Fed has en-

11
riched the public service. Thank you, Mr. Schultz. I yield back the
balance of all the time you gave me. [Laughter.]
The CHAIRMAN. The Chair will assure the chairman of the subcommittee that all members will read his statement very assiduously.
At this point the Chair would like to recognize Mr. Schultz.
STATEMENT OF HON. FREDERICK H. SCHULTZ, VICE CHAIRMAN,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

Mr. SCHULTZ. Thank you very much, Mr. Chairman. I am most
appreciative of the comments that you and Congressman Stanton
and Congressman Fauntroy have made. I would just note that it is
easy to look good when there is good leadership, and Paul Volcker
has provided that leadership.
I hope you will excuse me. I need to go chair a Board meeting. It
is interesting that when I was sworn in, Chairman Miller was
moving out something had occurred which required a Board meeting, so I chaired the first Board meeting that I ever attended. I am
now about to chair my last Board meeting.
I will miss the Fed very much. One of the things that I will not
miss is the fact that I sat between the Chairman and Governor
Wallich, both of whom smoked cigars. [Laughter.]
I shall not comment on the quality of those cigars. [Laughter.]
I would, however, sincerely request that if you can keep the
Chairman here long enough today I can chair the Board meeting
with just half of that twosome and, therefore, only half of the cigar
smoke. [Laughter.]
Thank you very much. [Applause.]
The CHAIRMAN. Mr. Barnard asks if you have any other promises
that you can make us that you can keep if we can keep Mr.
Volcker here long enough.
Chairman Volcker.
STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM

Chairman VOLCKER. I would like to proceed with my statement,
Mr. Chairman, but I do want to take this opportunity to acknowledge from my point of view the enormous service that Fred Schultz
has given to the Federal Reserve and to the Nation generally, and
I certainly have been in a position to appreciate that more than
anyone else. We are going to miss him greatly. We can only thank
him for his willingness to serve during this period.
I appreciate the opportunity to meet with members of this distinguished committee today to discuss the direction of monetary
policy and the prospects for the national economy. I have submitted for the record the official report from the Board in accordance
with the Humphrey-Hawkins Act. I would now like to take a few
minutes to underscore and amplify some of the points in that
report, as well as to offer some more personal views on the problems—and equally important, the opportunities—that are before
us.
As you know, the economy has been in recession for some
months. The recession has some of the characteristics of earlier

downturns. But it seems to me plainly wrong to think of the current state of the economy as simply reflecting "another" recession.
Rather, we are seeing the culmination of a much longer period of
unsatisfactory economic performance extending well back into the
1970's—performance marked by poor productivity, growing unemployment, much higher interest rates, and pressures on the real
earnings of the average citizen and on the real profits of our businesses.
A number of factors have contributed to that deterioration in our
performance, not all of them completely understood. But one pervasive element—an element particularly relevant to monetary
policy—stands out: we found ourselves in the midst of the most
prolonged inflation in our history, and that inflationary process
had come to feed on itself. Incentives were distorted. Too much of
the energy of pur citizens was directed toward seeking protection
from future price increases and toward speculative activity, and too
little toward production. Increasingly depressed and volatile capital
markets reflected the uncertainties. Effective tax rates increased as
inflation carried taxpayers into higher brackets. But, in a sluggish
economy, those revenues did not keep up with our spending plans
and programs.
Against that background, the notion that we might comfortably
live with inflation—or that we could accept inflation in the interest
of strong growth—was exposed as an illusion. I believe it is fair to
say a clear national consensus emerged that turning back inflation
had to be a top priority of economic policy—that a stable dollar is a
necessary part of the foundation of a strong economy.
Monetary policy has a key role to play in restoring that stability,
and our policies are directed to that end. But recent developments
have confirmed again that ending an inflation, once it has become
deeply seated in expectations and behavior, is not a simple and
painless process. The problems can be aggravated if too much of
the burden rests on one instrument of policy. And the effort to restore stability will be more difficult to the extent policies feed skepticism and uncertainty about whether the effort will be sustained—
a skepticism rooted in past failures to "carry through." Monetary,
fiscal, and other public policies are constantly scrutinized—in financial markets and elsewhere—to detect any signs of weakening
in the sense of commitment to deal with inflation. To speed the
transition to lower interest rates and healthier capital markets, to
reduce the costly elements of anticipated inflation built into wage
and price contracts, to permit more confident planning for the
future—to, in fact, lay the base for sustained recovery—credibility
in dealing with inflation has to be earned by performance and persistence.
That, essentially, is what public policy—and monetary policy in
particular—has been about for some time, and there are now signs
of real progress on the inflation front. That progress is reflected to
greater or lesser degree in all the widely used inflation indices.
Consumer prices rose 8.9 percent last year, SVfe percentage points
less than the 1980 peak, and the inflation rate seemed to be trending lower still as the year ended. Finished goods producer prices
have had an average increase at an annual rate of only about 4
percent for 6 months. Expectations cannot be so easily measured,

but earlier fears that inflation might rapidly accelerate have plainly dissipated.
Those gains, to be sure, have elements that may not be lasting.
Some prices are depressed by recession-weakened markets, and
some by the pressures of high interest rates on inventories and
speculative positions; exceptionally good crops last year have held
food prices down; and surpluses have emerged in oil markets, following the enormous price increases of earlier years.
But we also see evidence of potentially more lasting changes in
the trend of costs as management and labor in key industries come
to grips with competitively damaging productivity and wage trends.
I am aware that this process has just begun, and it has been centered largely in areas where competitive pressures are most intense. But as the emerging patterns spread, we will have succeeded
in establishing one of the major elements for success in the fight
against inflation and for reconciling, as we must, a return to greater price stability with growth, reduced unemployment, and higher
real wages. Quite obviously, policies that encourage that process of
cost moderation will have a large "pay off' in future economic performance.
I am acutely aware that progress on the inflation front has been
accompanied by historically high levels of interest rates and heavy
strains on financial markets. Those sectors of the economy particularly dependent on borrowing—especially long-term borrowing—
have been hard hit.
The pattern of economic activity last year shows the picture
clearly. Over the course of 1981, the overall level of production of
goods and services—real GNP—posted a slight increase. But at the
same time, homebuilding dropped to the lowest level in decades.
Sales of consumer durables—car sales in particular—fell markedly.
And now capital investment by businesses also appears to be adversely affected, running contrary to longer term needs.
It would be simplistic to cite high interest rates as the sole cause
of the difficulties in these vulnerable sectors. Part of the problem
arises from other, and longer term, factors, themselves associated
with the inflationary process. In housing, for example, we have had
a decade of increases in prices of homes almost double the rate of
inflation in the economy generally and well in excess of the rise in
average family income. "Sticker shock" still seems to be the major
deterrent to new car sales as the industry comes to grips with long
developing competitive and regulatory problems and the enormous
challenge of adapting to the higher price of gasoline.
In the best of circumstances, coping with deep-seated inflation
would pose difficulties. At the same time, we have had to adjust to
the huge increases in the price of energy, to meet the need for a
stronger defense, and to deal with the drag on incentives and investment resulting from rising marginal tax rates. All of that implies massive economic adjustments, the threat of a growing fiscal
imbalance, and a difficult transition period. The high level of unemployment generally, and particularly distressing conditions in
some of our older industrial centers, are one symptom. Lasting
progress toward price stability—and other needed adjustments—
cannot be built on prolonged stagnation, rising unemployment, and
slow growth. The relevant question is not whether current condi-

tions are satisfactory or tolerable—they obviously are not. It is
whether our policies, and our policy mix, promise to achieve the
needed results over time.
MONETARY POLICY IN 1981 AND THE TARGETS FOR 1982

It is against that background that I would like to review monetary policy last year and discuss our intentions for 1982.
As you know, the main responsibility for dealing with inflation
has fallen on monetary policy. I would emphasize that the process
of restoring stability will proceed more easily and effectively, with
less strain on financial markets and on credit-sensitive sectors of
the economy, to the extent the effort is complemented and supported by other policies. But, in the end, history and theory alike confirm that no effort to turn back inflation can be successful without
appropriate restraint on the expansion of money and credit. I believe the record of the past few years amply reflects the needed
monetary discipline.
The Humphrey-Hawkins Act specifically requires that we translate our broad objectives into quantitative monetary and credit targets. More broadly, those targets have become one means of communicating our intentions to the public in a comprehensible way.
The judgments involved in setting appropriate targets are never
simple, and they have been increasingly complicated by the rapid
pace of innovation in financial markets. Those innovations sometimes blur the precise meaning of the various monetary and credit
aggregates, complicate their measurement, or change the economic
significance of a particular target. In the circumstances, elements
of judgment are necessary in interpreting behavior of the aggregates, particularly when their movements diverage somewhat.
The events of 1981 surely reflect those facts, but they also seem
to me to provide an unambiguous record of persistent monetary restraint. The targets we set for the year pointed toward a reduction
in the growth of the monetary aggregates from the rates of expansion in 1980. In our 1981 report to the Congress, setting forth those
targets, we also suggested that changing preferences of the public
for different types of financial assets—influenced by regulatory developments and new "products" offered by financial institutions—
might tend to push the broader aggregate M2 to the upper part of
its specified range, and that judgments about the course of the
narrow aggregates—MiA and B—would require taking account of
shifts into NOW accounts, particularly during the early part of the
year when they were newly introduced nationwide. These expectations were borne out, but as the year progressed the divergences
among some of the aggregates became even wider than expected.
Measured by comparing fourth quarter averages in 1980 and
1981, MIB growth
(adjusted for the estimated shift of funds into
now accounts)1 in 1981 was 2.3 percent, a little more than 1 per1
The "adjustment" allowed for shifts of funds into NOW accounts and similar instruments
included in MiB from sources outside of MiB. The shift-adjustment was estimated on the basis of
various surveys of depository institutions and individuals, as well as by statistical techniques.
Mi B without adjustments rose by 5 percent, also below its indicated range. While the adjustment
was necessarily estimated, we believe the "adjusted" data are more appropriate for assessing the
trend in the money supply, particularly during the early part of the year when shifts were
large.

cent below the lower end of the target range specified 1 year ago
(see table 1 attached). You will recall that I reported to you in July
that an outcome near the lower end of the range would be desirable.
Measured in the same way, M2 slightly exceeded the upper end
of its range after rather closely following the upper bound as the
year progressed. The subsidiary target range for M3 was exceeded
by a greater margin, reflecting in considerable part some changes
in the composition of commercial bank financing patterns toward
domestic sources that had not been anticipated, while bank credit
fell within, but toward the upper part of, its range.
In judging trends over a period of time, annual averages may be
more meaningful. As table 2 illustrates, average annual MiB—adjusted—growth has declined by an average of 1.1 percentage point
since 1978, to a rate of 4.7 percent in 1981. On the same basis, M2
growth was steady in 1979 and 1980, but actually rose by more
than 1 percentage point in 1981. Over those years, both aggregates
have been affected by institutional change. Relaxation of interest
rate ceilings applicable to time deposits of depository institutions
and the enormous growth of money market funds—both included
in M2—tended to raise the trend of M2 over the period as individuals had incentives to lodge a larger proportion of their assets in
these instruments. Assets in money market mutual funds are not
included in Mi, but the enormous growth of those funds, providing
virtually immediate availability of funds and checkwriting privileges, diverted some money away from checking accounts in depository institutions which are included in Mi. Given the technical and
institutional changes bearing on Mi and its relative volatility, its
movements need to be assessed in light of developments with respect to the other aggregates. Indeed, a number of analysts attach
greater weight to M2.
Experience during 1981 also illustrates the variety of forces impinging on interest rates and credit market conditions. Over long
periods of time, there should be a relationship between interest
rates and inflationary expectations—that is, both lenders and borrowers might reasonably anticipate a small positive return on loanable funds in "real" terms, after allowing for inflation. When economic conditions were relatively stable in the postwar period and
inflation low, that relationship with respect to long-term interest
rates were fairly steady. But history is replete with deviations for a
time in either direction, and high levels of income taxation distort
the comparison. Before taxes, "real" interest rates—measured on
the base of actual inflation—were negative during part of the seventies, but recently have been extraordinarily high. One factor,
particularly in long-term markets, appears to be concern about
whether public policy will, in fact, "carry through" the fight on inflation.
Even with inflation subsiding, the threat of prolonged large Federal deficits as the economy recovers points to a more imminent
concern—direct Government competition for a limited supply of
savings and loanable funds. The clear implication is greater pressure on interest rates than otherwise, with those interest rates
serving to "crowd out" other borrowers. The most vulnerable, of
course, are home buyers and other particularly dependent on

credit. But the consequences for business investment generally are
adverse as well.
Monetary policy, of course, influences interest rates, but the relationship has several dimensions. As monetary restraint reduces
and eliminates the risk of inflation over time, it will work powerfully toward a more favorable climate for longer term borrowing,
and in the credit markets generally. In the short run, should inflation, economic growth or other factors increase the need and desire
to hold money, restraint on the supply of money will ordinarily be
reflected in pressures on short-term rates. However, to accept inflationary increases in the money supply in an attempt to lower interest rates would ultimately be self-defeating; even in the short run,
market sensitivities might well give the opposite result.
Some of these interrelationships were evident in 1981. Shortterm interest rates fluctuated over a wide range, but generally
trended down from peak levels in the spring or early summer, falling particularly sharply as the recessionary forces became apparent in the fall. That was a period when pressures on commercial
bank reserves positions were easing, consistent with our monetary
and credit targets. However, longer term interest rates continued
to rise for months after the peak in short-term rates, influenced in
substantial part by growing concern about prospective budgetary
deficits.
As growth in the money supply rose more rapidly late last year,
and a very sharp increase developed early in January, the reserve
positions of banks came under some renewed pressure as Federal
Reserve open market operations constrained the supply of reserves.
At the same time, there were scattered signs recessionary forces
might be waning. Short-term interest rates rose from early November lows, although they remain well below levels prevailing during
much of 1981. Some long-term interest rates—notably those on
Government securities—returned close to ealier peaks, suggesting
the impact of current and prospective Treasury financing.
This was the setting for the decision on the monetary and credit
targets taken by the Federal Open Market Committee last week.
The sharp increase in the money supply in January carried the
level well above the fourth quarter 1981 average, the conventional
base for the new target, and somewhat above the lower end of the
range specified for 1981. A large increase in the money supply, accompanied by higher interest rates, is unusual during a perod of
declining production and economic activity. Moreover, the composition of the money supply increase in the past 3 months is heavily
concentrated in a rather small component of Mi—NOW accounts,
which are held by individuals. That increase in NOW accounts has
been accompanied by a reversal of earlier sharp declines in savings
accounts—another highly liquid asset—and by declines in small
time deposits, which provide a less liquid outlet for personal funds.
Taken together, the evidence suggests some short-term—and potentially "self-reversing"—factors may be at work, inducing individuals to build up highly liquid balances at a time of economic and
interest rate uncertainty.
Taking those circumstances and others into account, the Federal
Open Market Committee decided to adopt the tentative targets dis-

cussed last July:
For Mi, 2Vfc to 5l/2 percent; for M2, 6 to 9 percent;
J
for M3, 6 ¥2 to 9 /2 percent.
The associated range for bank credit is 6 to 9 percent.2
The Mi target is lower than the range specified a year ago for
MIB (3V2 to 6 percent shift-adjusted), but it is consistent with somewhat larger actual growth than experienced last year with the "adjusted" measure. The lower end of the range would now appear appropriate only if the pace of financial innovation again picks up—
for instance, a rapid spread of arrangements for "sweeping" temporarily excess checking account balances into money market funds
or other liquid assets not included in the Mi. Given the present
level of Mi and the relatively slow growth last year, the FOMC at
this time feels that an outcome in the upper half of the range
would be acceptable, and that Mi could acceptably remain somewhat above the implied "growth track" during the period immediately ahead.
In that connection, I would point out that an outcome in the
upper part of the range specified for 1982 would be roughly the
equivalent of a rate of growth of 4 percent from the lower end of
the range targeted in 1981, as illustrated on chart II. Such a result
would be entirely consistent with the objective I stated to your
committee in July.
The FOMC anticipates somewhat slower growth in M2 than a
year ago, when the target was slightly exceeded. At present, an
outcome in the upper half of the range appears more likely and desirable. Assets included in M2 account for a significant part of individual savings. Should total savings increase substantially more
rapidly than now anticipated in response to tax incentives or other
factors—or if legal or regulatory changes, such as the wider availability of IRA accounts, result in a substantial volume of funds
shifting into depository institutions from other sources—growth
might logically reach (or even slightly exceed) the upper limit.
Identifiable "structural'' influences of that sort on M2, or other
aggregates, must appropriately be taken into account in formulating policy steps and judging actual developments. For example,
should developments in coming months provide solid evidence that
the recent exceptional growth of Mi is indicative of some more fundamental and lasting change—such as a desire by individuals to
continue to hold more liquid savings in the form of NOW accounts—the FOMC would, of course, reconsider that growth target
at or before the regular midyear review.
These technicalities should not confuse a simple message: Consolidating and extending the heartening progress on inflation will
require continuing restraint on monetary growth, and we intend to
maintain the necessary degree of restraint. The growth ranges
specified are, we believe, consistent with an economic recovery
later this year, although we do not anticipate, by historical standards, a sharp "snap back." What is more important is that the re2
While all of the monetary ranges were set, as in previous years, on a fourth-quarter to
fourth-quarter basis, the range for bank credit is measured from the average level in December
1981 and January 1982 to the fourth-quarter 1982 level. This adjustment in the base for bank
credit is necessitated by the opening of International Banking Facilities on December 3, 1981,
which led to a shifting of cetain bank assets, formerly included in the domestic bank credit data,
from U.S. offices to the IBF's.

covery have a firm foundation—that it be sustained over a long
period. There will be more room for real growth—and much better
prospects for sustaining that growth over many years—the greater
the progress on inflation.
THE COURSE AHEAD

In approaching the future, the lessons of the past bear repeating.
We cannot buy or inflate our way out of recession—not without
ratcheting up both inflation and unemployment over time. We
cannot turn the effort to deal with inflation "on and off—not
without adversely influencing the decisions of those in the marketplace who commit funds for investment, with consequences for the
recovery and productivity we want.
What we can do is set the stage for a much more favorable outlook—a future in which progress toward price stability, lower interest rates, greater productivity, slower growth in nominal wages but
higher real wages, all benignly interact to support growth and
reduce unemployment. That's a process we have not seen sustained
in this country for many years.
Today, we are acutely aware of disturbed capital markets, high
interest rates, economic slack, and a poor productivity record. But,
when the economy begins to expand, productivity should rise; tax
and other measures already in place or under way should help reinforce a better trend. Productivity growth, in turn, will permit
prices to rise more slowly than wages—more modest wage and
salary increases in dollars will then be consistent with more
growth in real earnings, encouraging further moderation in wage
demands and sustaining the disinflationary process. As confidence
returns to securities markets, prices of bonds and stocks should
rise, and lower interest rates and more favorable capital market
conditions will in turn support the continuing growth in investment and productivity. With appropriate budgetary and monetary
discipline, the process could be sustained for years.
That is not an impossible vision. We saw something of it in the
early 1960's. As recently as the mid-1970's, coming out of a deep
recession, we seemed to be moving in the right direction—and then
lost our way. Some of the essential elements of a brighter future—
as well as some of the hazards on the way—are reflected in the
longer term projections of both the administration and the Congressional Budget Office now available to you.
From the standpoint of public policy, much of the groundwork
has been laid. I have spoken of the key role for monetary policy,
and of our record and intentions in that regard. The tax program
enacted last year can, in the right context, have favorable effects
on incentives and on investment. The excessive burden of regulation is being addressed.
But, of course, for the process to get fairly started we need to resolve some large outstanding questions as well—questions that
hang heavily over financial markets and prospects for interest
rates, inflation, and early recovery.
I have referred on many occasions to the key importance of
winding down on the cost and wage pressures that tend to keep the
inflationary momentum going. The process appears to be starting,

and the faster it takes hold the better the outlook for growth and
reduced unemployment. But, clearly, prospects for early and sustained expansion—an expansion that can be broadly shared by industries now severely depressed—is dependent on access to capital
and credit on more favorable terms. Pumping up the money supply
cannot be the answer to that problem—excessive money and the inflation it breeds are enemies of the real savings needed to finance
investment.
What we can do is relieve the concerns the markets understandably have—concerns reflected so strongly in the budgetary documents before you from both the administration and your own
budget office. Without action to cut spending—or, if that fails, to
raise new revenues—we would face the prospect of deficits rising to
unprecedented amounts, whether measured in dollars, in relation
to the GNP, or as a proportion of our limited savings and the
supply of loanable funds. We can debate among ourselves just what
level of deficit is tolerable in coming years and what is not. We can
be tempted to sit back and let a year pass as we discuss what programs should be cut or where revenues can be raised. But I think
we all know that, without action, we would be on a collision course
between our need for new plant, equipment and housing and our
capacity to save—and it would be more difficult to reconcile the requirements for a sound dollar with our desire to grow.
It could be argued we have a little time. A large deficit in the
midst of recession should be manageable; it indeed provides some
support for the economy in a time of stress. There are also large
potential sources of demand in the private economy. The latest economic indicators are not so weak as they were. We can see we are
making some progress against inflation, perhaps as fast as could
reasonably have been anticipated. In all these circumstances, a
degree of patience is needed—and justified.
But delay in another matter. In my judgment, the more progress
we can see in restraining costs, and the more resolute your budgetary action, the earlier we can be assured a prompt and strong recovery.
The course of action we have set in the Federal Reserve seems to
me consistent with that sense of direction and urgency. But no
single instrument of policy can, alone, do the job. We look forward
to working with you and your colleagues in the weeks and months
ahead to meet these challenges constructively.

20
Table 1
Monetary Growth 1981

1981 Actual*

1981 Ranges
6 to 8-1/2 percent
3-1/2 to 6 percent
6 to 9 percent
6-1/2 to 9-1/2 percent
6 to 9 percent

Ml-B
Ml-B (shift adjusted)
M2
M3
Bank Credit

5.0
2.3
9.4
11.3
8.8

percent
percent
percent
percent
percent**

*Fourth quarter to fourth quarter
**December level used for calculating this 1981 growth rate
incorporates an adjustment to abstract from the shifting
of assets from domestic banking offices to International
Banking Facilities.
Table 2
Growth of Money and Bank Credit
(percentage changes)

Ml-B*

8.3
7.5
6.6
2.3

8.2
7.7
5.9
4.7

Bank Credit

8.3
8.4
9.1
9.4

11.3
9.8
9.9
11.3

13.3
12.6
8.0
8.8**

8.8
8.5
8.3
9.8

11.8
10.3
9.3
11.6

12.4
13.5
3.5
9.4**

Fourth quarter to
fourth quarter
1978
1979
1980
1981
Annual average to
annual average
1978
1979
1980
1981

*Growth rates for 1980 and 1981 adjusted for shifts to other
checkable deposit accounts since the enJ of the preceding year.
**December level used for calculating thase 1981 growth rates
incorporates an adjustment to abstract from the shifting of
assets from domestic banking offices to International Banking
Facilities.

21
Table 3
Monetary Growth Targets 1982

Ml*
M2
M3
Bank Credit

2-1/2 to 5-1/2 percent
6 to 9 percent
6-1/2 to 9-1/2 percent
6 to 9 percent**

*The objective for growth of narrowly defined money
over 1981 is set in terms of Ml. Based on a variety
of evidence suggesting that the bulk of the shift to
NOW accounts had occurred by late 1981, the Federal
Reserve is publishing only a single Ml figure in 1982
with the same coverage as the former Ml-B.
**The bank credit data after December 1981 are not
comparable t6 earlier data because of the introduction
of International Banking Facilities. Thus, the targets
for 1982 are in terms of growth from an average of
December 1981 and January 1982 to the fourth quarter
average of 1982.

22
Growth Ranges for 1981 and Actual
M1-B SHIFT-ADJUSTED

Billions of dollars

430

410
January 1982 estimated on a basis comparable to shift-adjusted M1-B in 1981

1980

1981

I
1982

M2
Billions of dollars

1800

1750

1700

1650

1980

1981

1982

Growth Ranges for and Behavior of M1, 1981 and 1982
Billions of dollars
470
5V 2 %

440

M1-B (shift-adjusted)

1981

[Chairman Volcker submitted the following report of the Board
of Governors of the Federal Reserve System, dated February 10,
1982, entitled "Monetary Policy Report to Congress Pursuant to
the Full Employment and Balanced Growth Act of 1978":]

24
Board of Governors of the Federal Reserve System

Monetary Policy Report to Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978

February 10, 1982

Letter of Transmittal

BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 10, 1982
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES.
The Board of Governors is pleased to submit its Monetary Policy Report to the Congress pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely,
Paul A. Volcker, Chairman

Section 1:

Monetary Policy and the Performance of the Economy in 1981

The economy was growing rapidly as 1981 began, continuing the sharp
cyclical rebound that started in mid-1980.

Activity leveled out during the

spring and summer, however, and it fell in the final quarter of the year.

a result, the rate of production of goods and services—real GNP—was only
slightly higher at the end of 1981 than it had been a year earlier.

With the

weakening of output late in the year, the margin of unutilized plant capacity
widened and the unemployment rate rose sharply to near postwar record levels.
While economic activity was disappointing last year, there were
emerging signs of progress in reducing inflationary pressures.

The rate of

price inflation slowed from the extremely rapid pace of the preceding two
years, and as 1981 progressed there also were indications of an easing in the
rate of wage increases, particularly in some key pattern-setting industries.
Confidence in the restoration of reasonable overall price stability is needed if economic growth is to be resumed on a sustained basis.

The

accelerating inflation of earlier years had been eroding the foundations of
the nation's economy:

capital formation had slowed; productivity was sagging:

the functioning of basic market mechanisms was being impaired; and inequitable and capricious transfers of wealth were harming many of the weakest
among us.

The task of reversing the inflationary trend of earlier years was

made more difficult because a decade of escalating prices and unsuccessful
anti-inflation policies had led to firmly held expectations of continued
high—if not accelerating—rates of inflation.

Thus, it was recognized that

reducing inflation would take time and that anti-inflation policies would

26
Gross Business Product Prices
Change from Q4 to Q4, percent

Fixed-Weighted Index

1981

10.5

8.2

9.9

7.1

—

— 12

—

1977

1979

1978

1980

Real GNP

1981

Change from Q4 to Q4, percent

1972 Dollars
1981

1978

8.6
-1.6
1.4
—5.2

I
1977

Q1
Q2
Q3
Q4

1979

1980

1981

Interest Rates

Percent

Home Mortgage

3-Month Treasury Bill

_L
1977

1978

I
1979

1980

1981

have to be applied with persistence if they were to be effective in altering
expectations and slowing the rate of price increases.
While fiscal policy and decisions made in the private sector have
much to do with the course of economic developments, economic theory and
experience alike indicate that progress toward price stability cannot be
obtained without adequate restraint on the growth of money and credit.
tary policy was conducted in 1981 with this crucial fact in mind.

Mone-

The Federal

Reserve set objectives for the growth of the monetary aggregates that it
believed would help to damp inflation and would lead to movement over time
toward trend rates of monetary expansion consistent with the growth of potential output at stable prices.
Short-term market rates of interest began 1981 at record levels, as
rapid growth of economic activity in the second half of 1980 had pushed up
the demand for money and credit faster than could be accommodated within the
target ranges for growth of the monetary aggregates and bank reserves.

Early

in 1981 these demands began to subside, pressures on bank reserve positions
were relieved, and money market rates declined for a time.

A bulge in money

demand early in the second quarter was steadily resisted by restraining the
supply of reserves, and in the process short-term interest rates moved back
to their earlier highs.

By midsummer, short-term interest rates were declin-

ing, as demands for money and credit slackened while the Federal Reserve
expanded nonborrowed
growth.

reserves in an effort to maintain adequate monetary

Those interest rate declines accelerated in October and November

as the recession took hold.
On balance, short-term interest rates—although volatile—moved
down considerably over the course of 1981.

In contrast, long-term rates

rose substantially over the period, despite declines in the last quarter of
the year.

The pressure on long-term rates appeared to reflect a combination

of factors.

Anticipations that continued large federal budget deficits would

clash with private credit demands particularly as the economy expanded, putting strong pressures on credit markets, were a continuing strong investor
concern.

Despite reductions in the growth of many federal spending programs,

federal borrowing in calendar year 1981 siphoned off roughly a quarter of the
total funds available to domestic nonfinancial borrowers.

In the background

were continuing doubts and skepticism that anti-inflation programs would be
carried through.

Moreover, the volatility of the markets may have inhibited

aggressive buying of longer-term securities.
The tensions in credit markets in 1981 had their greatest impact
on business and household capital formation.

Housing construction fell to

its lowest level in the postwar period; only 1.1 million new housing units
were started in 1981.

The weakness in real estate markets last year reflected

a number of influences.

Of paramount importance, in the short run, was the

cost of mortgage funds.

The average rate on mortgages closed for new homes

was 15.3 percent in the fourth quarter of 1981, up from 12.6 percent a year
earlier.
demand:

But it was not higher mortgage rates alone that cut into housing
high prices also adversely affected the ability of those seeking

new homes to afford the monthly payments.

Although house prices changed

little in 1981, over the preceding 5 years prices of new and existing homes
had risen half again as fast as the overall rate of inflation.

As a result,

the share of average family disposable income needed to service the monthly
payment on a typical new mortgage rose from 21 percent in 1976 to nearly 40
percent last year.

Slow income growth and rising unemployment, along with the increased
cost of credit, combined to damp consumer spending in 1981—particularly for
more discretionary, large ticket items such as autos, furniture, and appliances.

Since the mid-1970s, household real after-tax income has only been

rising at a 1/2 percent annual rate, compared with a long-run trend of 2 percent.

At the same time, the prices of essential items such as food, gasoline,

heating fuel, utilities, and medical services—as a group—have been rising
faster than the overall inflation rate, and the share of disposable income
devoted to these items has been increasing.

The resulting squeeze on family

budgets led many households to overextend themselves during the last half of
the 1970s, taking on more and more debt to finance their purchases.
With household balance sheets debt-laden and credit costs rising, a
retrenchment in consumer borrowing began in 1980, and continued through 1981.
As the year progressed, it appeared that household balance sheets were improving.

Consumer debt burdens (the ratio of monthly debt repayment obligations

to income) declined to their lowest level in more than five years.

Moreover,

partly in response to the higher after-tax income following the tax cut on
October 1, the saving rate rose from about 5 percent in the first three
quarters of 19Sl to 6 percent in the fourth quarter.
In real terms, personal consumption expenditures rose 1-1/4 percent
over the four quarters of 1981.

The gain was concentrated in the early months

of the year as real consumer spending fell, on balance, over the final three
quarters of 1981.

Purchases of new automobiles were hardest hit.

Sales of

domestically produced cars totaled 6.2 million units in 1981, the poorest performance in 20 years.

The depressed conditions in the auto sector were related,

in part, to the typical cyclical volatility in the demand for motor vehicles
and to credit market conditions, which affected the cost of financing new car
and truck purchases.

However, the current problems in the industry appear to

be related mainly to longer-term trends in automotive demand.

These include:

the rapid increase in the price of new cars, high gasoline and other operating costs, sluggish real income growth, intense foreign competition, and
government regulations that have necessitated large investments to comply with
emission control standards and to improve fuel efficiency.

As 1981 was ending,

it appeared that the auto industry was taking aggressive actions to reduce
costs and to improve the competitiveness of its products.
Business firms, like households, restrained their spending on investment goods in 1981.

Demand was damped by a substantial degree of excess capa-

city and by the rising trend in corporate bond rates throughout much of the
year, which boosted the real cost of capital.

In real terms, expenditures for

new plant and equipment rose only 1-1/2 percent over the four quarters of 1981.
Although spending for new structures increased during the year, real equipment
outlays fell for the second year in a row; the biggest declines were for electrical machinery and transportation equipment, while spending for most other
capital goods remained weak.
In contrast to fixed investment outlays, sizable unintended inventory accumulation boosted business financing requirements.

As the year went

on, unexpectedly weak demand led to a build-up of excess stocks in several
industries.

The most pronounced problem was in autos, but other manufacturers

and retailers also found their inventory levels uncomfortably high relative
to sales.

On balance, total nominal business capital spending—fixed invest-

ment and inventories—rose about 20 percent above the 1980 average.

Early in 1981, strong economic growth helped boost corporate internal funds, greatly reducing corporate needs for external financing.

But as

the economy slowed, corporate profits turned sluggish and businesses were
forced to rely more heavily on credit markets to satisfy their rising capital
needs.

The bulk of business borrowing last year was in short-term markets,

as most firms felt it best to defer making long-run commitments in the current
financial environment.

With the accumulation of additional short-term debt,

however, corporate balance sheet positions deteriorated further, and the ratio
of short-term to total debt of the nonfinancial corporate sector rose to a
record high.
Real purchases of goods and services at all levels of government
rose only moderately during 1981 as a sharp increase in purchases by the
federal government was partly offset by curtailed spending at the state and
local level.

The rise in federal spending on goods and services reflected

another large increase in defense purchases, while federal payroll reductions
helped to contain increases in nondefense outlays. At the state and local
level, real purchases fell 2 percent owing to a combination of the withdrawal of federal support for many activities, the continued impact of tax
limitation measures, and the effects of a sluggish economy on tax revenues.
The weighted-average value of the dollar against major foreign
currencies' rose by nearly one-fourth during the period from January to
August.

The dollar eased somewhat in the last part of 1981, but at the end

of the year still remained well above its year-earlier level.

The improve-

ment ia the inflation outlook in the United States was a factor in the appreciation of the dollar.

Moreover, at various times during the year changes in

the differential between interest rates on dollar assets and rates of return
on foreign currency assets also had a noticeable impact on exchange rates.
Real exports of goods and services increased in the first quarter
of 1981, in part because of strong GNP growth in one of our major trading
partners, Canada.

But for the next three quarters, real exports declined in

response to a slowing of economic growth abroad and the effect of the appreciation of the dollar in 1980 and 1981.

The volume of imports, other than

oil, rose fairly steadily throughout the year.

The current account, reflect-

ing this weakened trade performance, shifted from a surplus in the first
quarter to a deficit by the fourth quarter.
Employment grew at a moderate rate during the first three quarters
of 1981 and the unemployment rate edged down.
in the service and trade sectors.

Job increases were strongest

As economic activity began to contract in

the autumn, the demand for labor fell sharply and the unemployment rate
climbed to 8.8 percent in December—only fractionally below its postwar high.
Layoffs in the durable goods and construction industries accounted for much
of the drop in employment.

As a result, the unemployment rate of adult men—

who tend to be more heavily employed in these industries—jumped to a postwar
record of 7.9 percent in December of

1981.

Labor productivity (output per hour worked) showed considerable
fluctuation during 1981, reflecting the course of economic activity.

Produc-

tivity rose at a 1-1/4 percent annual rate in the first three quarters of
1981.

However, as often happens at the beginning of a cyclical downturn, out-

put fell more than employment in the fourth quarter and productivity declined,
offsetting the gains earlier in the year.

Averaging across short-run cyclical

movements, productivity has shown little improvement in recent years, and thus
has provided virtually no offset to the impact of rapidly rising compensation
on unit labor costs.
Compensation and wage increases did decelerate during 1981—with
continuing progress observed throughout the year.

But the slowing was moder-

ate, reflecting the basic inertia of the wage determination process, where
many union contracts last three years or more and nonunion wage agreements
usually are set annually.

By the second half of 1981, however, some changes

in those traditional wage-setting practices were under way in several important industries:

management and workers alike began to reconsider planned

wage adjustments, some expiring contracts were renegotiated well in advance
of termination dates, and labor agreements at a number of firms were modified
in an effort to ease cost pressures and to enable them to compete more effectively.

These adjustments, coupled with the progress seen in reducing infla-

tion during 1981, suggest that the nation's anti-inflation policies have set
the stage for a sustained unwinding of wage and price increases.
The trend in inflation improved noticeably during 1981, and by yearend virtually all aggregate price indexes were advancing well below doubledigit rates for the first time since 1978.

The consumer price index rose 8.9

percent over the course of 1981, down from the nearly 13 percent average rate
in 1979 and 1980.

Important factors in the slowing of.- inflation were excep-

tionally favorable agricultural supplies and declines, after the first quarter,
in world oil prices.

Inflation in areas other than food and energy—particu-

larly consumer commodities and capital equipment—also began to abate, although
price pressures persisted in the consumer service sector, notably for medical
care.

As the year progressed, surveys of consumer expectations suggested that

the inflationary psychology, which had increasingly permeated many aspects of
economic behavior in earlier years, appeared to be subsiding.

34
-10-

Section 2:

The Growth of Money and Credit in 1981

The Board of Governors in its report to Congress last February indicated that the System intended to maintain restraint on the expansion of money
and credit in 1981.

The specific ranges chosen by the Federal Open Market

Committee (FOMC) for the various monetary aggregates anticipated a deceleration in monetary growth that would encourage further improvement in price performance.

Measured from the fourth quarter of 1980 to the fourth quarter of

1981, and abstracting from the effects on deposit structure of the authorization of NOW accounts nationwide, the ranges adopted were as follows:

for Ml-A,

3 to 5-1/2 percent; for Ml-B, 3-1/2 to 6 percent; for M2, 6 to 9 percent; and
for M3, 6-1/2 to 9-1/2 percent.

The associated range for commercial bank

credit was 6 to 9 percent.
In formulating its objectives for 1981, the FOMC knew that the growth
rates of the narrow aggregates would be affected markedly by shifts into NOW
accounts which for the first time became available on a nationwide basis in
January.

Transfers into NOW accounts, which are included in Ml-B, from savings

deposits and other asset holdings not included in Ml were expected to be particularly large in the early months of the year.

Thus, in order to avoid confu-

sion about the intent of policy and to facilitate comparisons with previous
years, the objectives announced for Ml-B abstracted from such shifts.1

Even

after accounting for such shifts, however, the FOMC anticipated that the growth
rates of the various aggregates were likely to diverge more than usual, reflecting the rapid pace of institutional change in financial markets.

The FOMC indi-

cated that if Ml-B growth (adjusted for shifts into new NOW accounts and other
1. The shift adjustments were estimated on the basis of survey evidence and
were published regularly over the past year.

-iicheckable deposits) was about in the middle of its annual range, the growth
of M2 was likely to be in the upper part of its range, given the popularity
of the nontransactions components of M2 that pay market-related interest
rates.

It also was noted that the relationship of M3 and bank credit to their

respective ranges would be influenced importantly by the pattern of credit
flows that would emerge, and particularly by whether financial conditions
would be conducive for corporations to refinance short-term borrowing in the
bond and equity markets.
It soon became apparent as 1981 unfolded that the behavior of the
aggregates was turning out to be even more divergent than had been anticipated.
Growth rates of the shift-adjusted narrow aggregates were low in the opening
months of the year, a development that was welcome following rapid growth in
the latter part of 1980.

A strong surge in April was offset by weakness over

the remainder of the second quarter.

On the whole, average growth in adjusted

Ml-B over the first half of 1981 was well below that which would have been expected on the basis of historical relationships among money, GNP, and interest
rates.

On the other hand, despite the weakness in Ml-B, the broader aggre-

gates expanded quite rapidly in early 1981.

M2 growth over the first half was

near the upper end of its annual range, while the expansion of M3 placed this
aggregate above the upper bound of its range at midyear.
After reassessing its objectives for 1981 at midyear, the FOMC
elected to leave unchanged the previously established ranges for the aggregates over the remainder of the year.

However, in light of the reduced

growth in Mi-type balances over the first half of the year, indications that
this weakness might reflect a lasting change in cash management practices of

individuals and businesses related to the growth of alternative means of holding highly liquid funds, and given the relatively strong growth of the broader
aggregates, the FOMC anticipated that growth of the narrow aggregates might
likely and desirably end the year near the lower bounds of their annual
ranges.

Even so, given the sluggishness early in the year, this decision

implied that growth of Ml-A and Ml-B would accelerate over the balance of the
year.

At the same time, the FOMC indicated that M2 and M3 might well end the

year around the upper ends of their ranges.

This expectation also reflected

in part the possibility that regulatory and legislative actions as well as
the popularity of money market mutual funds might intensify the public's
preference to hold the type of assets encompassed in the broader aggregates.
Although growth of narrow money in the second half of the year was
on average about the same as in the first half, Ml-B strengthened appreciably
in the final two months of the year.

This acceleration appeared to reflect

in part a lagged response to large short-term interest rate declines in the
summer and fall and in part a shift in preferences for very liquid assets in
an environment of heightened economic and financial uncertainty.

Similarly,

M2 growth in the second half was about in line with expansion in the first
half, although growth in this measure also picked up at the end of the year.
The expansion in M3, on the other hand, decelerated from the rapid pace of
the first half, as sales of large CDs slowed in concert with a slackening in
bank credit growth and stronger growth in core deposits.
Measuring growth for the year from the fourth quarter of 1980 to
the fourth quarter of 1981, Ml-B growth adjusted for shifts into NOW accounts
was about 2-1/4 percent—1-1/4 percentage points below the lower end of its

37
Growth Ranges and Actual Monetary Growth
M1-A Shift Adjusted*
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for
1980 Q4 to 1981 Q4

F j

I A |

1980 Q4 to 1981 Q4

1.3 Percent

| J j

A |

O j

1980

M1 -B Shift Adjusted*
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for
1980Q4 to 1981 Q4

450

1980 Q4 to 1981 Q4

2.3 Percent

440
430
420
410
0 I

I D|

I F|

| A|

| J |

1980

| A |

| O|

1981

M1-B
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for
1980Q4to 1981 Q4*

, 8'/2%

450

1980 Q4to 1981 Q4
5.0 Percent

440
430
420
410

o I

IDI

1980

IA|
1981

*• Adjusted for impact of nationwide NOW accounts.

38
Growth Ranges and Actual Monetary and Bank Credit Growth
M2
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for

1980 Q4 to 1981 Q4

1 9 8 0 Q 4 t o 1981 Q4

1800

9.4 Percent

1700

0 |

| D

1980

M3
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for
2150

1980 Q4 to 1981 Q4

1980 Q4 to 1981 Q4
11.4 Percent

2100
2050

2000

1950

I Q I

I D

1980

Bank Credit*
Billions of dollars
Annual Rate of Growth
Range adopted by FOMC for

1980 Q4 to 1981 Q4

8.8 Percent

1300

| J
1981

| o |

*Data prior to February are adjusted for discontinuity in series December figure is adjusted
for shift of assets into International Banking Facilities

39
-13-

targeted range.1

Growth rates, of course, are affected by the particular

pattern of variation that develops over the course of the year.

Measuring

expansion from December to December, "adjusted" Ml-B growth in 1981 was at a
3-1/2 percent rate.

On a yearly average basis, which reflects movements

through the year as a whole relative to the level of the previous year, the
increase was at a 4-3/4 percent rate.

At the same time, measured from the

fourth quarter of 1980 to the fourth quarter of 1981, growth of M2 was 9.4
percent, 0.4 percentage point above the upper limit of its range.

Also,

growth of M3 exceeded the upper end of its range by 1.9 percentage points,
while bank credit growth was just inside the upper end of its annual range.
The table on page 14 puts the performance of the aggregates during
1981 into a somewhat longer-term perspective, showing two measures of annual
growth.

No matter which of the measures of annual growth is used, a marked

deceleration in Ml-B is apparent since 1978.

The table also clearly illus-

trates that growth rates for the broader aggregates have been maintained
around a higher level, and larger divergences have developed from Ml-B
growth.

In considerable part, these differences can be explained by struc-

tural changes in financial markets.
As noted earlier, it was already obvious last February when the
FOMC was meeting to set its objectives for 1981 that shifts into NOW accounts
following their nationwide authorization at the beginning of 1981 would alter
the behavior of the narrow aggregates.

Data for early January had pointed

to a very large movement of funds at the beginning of the year.

However,

1. Unadjusted for shifts into NOW accounts, Ml-B increased 5.0 percent from
the fourth quarter of 1980 to the fourth quarter of 1981.

40
-14-

Growth of Money and Bank Credit
(percentage changes)

Bank
Credit2

Ml-B1

M-2

M-3

1978

8.3

11.3

13.3

1979

7.5

8.4

9.8

12.6

1980

6.6

9.1

9.9

8.0

1981

2.3

9.4

11.4

8.8

1978

8.2

8.8

11.8

12.4

1979

7.7

8.5

10.3

13.5

1980

5.9

8.3

9.3

8.5

1981

4.7

9.7

11.5

9.4

Fourth quarter to
fourth quarter

Annual average to
annual average

1. Growth rates for 1980 and 1981 adjusted for shifts to other checkable
deposit accounts since the end of the preceding year.
2. December level used for calculating these 1981 growth rates incorporates
an adjustment to abstract from the shifting of assets from domestic banking
offices to International Banking Facilities.

41
-15-

the pattern and magnitude of subsequent movements could not be predicted with
any certainty.

As events unfolded, the shifts into NOW accounts were more

concentrated in the early part of 1981 than was anticipated by the working
assumptions of the Board's staff.

Through June, the adjustments made to the

aggregates to correct for such shifts had the effect of raising Ml-A by $28
billion and lowering Ml-B by $9-1/2 billion.

Over the second half of 1981,

further adjustments for shifts into NOW accounts raised Ml-A by only another
$6 billion and lowered Ml-B by about $2-1/2 billion more.

While these adjust-

ments are imprecise and based on evidence from a variety of sources, data on
the number of NOW accounts coupled with other available information confirm
that the shifting of funds from demand deposits to new interest-bearing checking accounts tapered off considerably by the fall.

A surge in NOW account

balances near the end of the year and early in 1982 appeared to reflect primarily the precautionary savings behavior noted above rather than shifting
of funds into new accounts.
As was indicated above, the growth of the narrow aggregates adjusted
for shifts into NOW accounts was low in 1981 compared with the other aggregates
and also relative to past relationships with income and interest rates.

Con-

tinued high interest rates provided a substantial incentive for businesses to
intensify efforts to pare narrow money balances and to make increasingly widespread use of sophisticated cash management techniques.

At the same time,

explosive growth of money market mutual funds (MMMFs), many of which offer
check-writing or other third party payment services comparable to conventional checking accounts, appeared to induce some households to minimize
checking account balances.

Also, the broader availability of NOW accounts

42
-16-

may have stimulated households to reconsider in a more general way their
habits of cash management.
Likewise, the strong growth of M2 over the past few years reflected
changing financial practices.

Money market funds and instruments offered by

depository institutions that pay market-related

interest rates have been

accounting for an increasing proportion of M2, as such assets have become
much more competitive with open market instruments.

Indeed, the attractive-

ness of small time deposits was enhanced last year by the liberalization of
the interest rate ceilings on small savers certificates and to a limited
extent by the introduction of all savers certificates.

Even so, three-fourths

of the increase in the nontransactions components of M2 was accounted for
by MMMFs which grew 140 percent last year.
The distortions in the aggregates resulting from the expansion in
MMMFs are difficult to quantify.

Surveys of household behavior and data on

account turnover suggest that most shareholders of money funds have made
little or no use of their accounts for transactions purposes.

Thus, the

direct substitution effect of MMMFs on the growth of Ml has appeared small,
perhaps on the order of 1 percentage point on the rate of growth for the
year.

However,' indirect effects may have been larger as the potential avail-

ability of such a highly liquid asset may facilitate holding less funds in
demand and'NOW accounts.
The direct effect of MMMFs on M2 appears more substantial in dollar
terms.

Presumably, the great bulk of the $20 billion inflow in 1981 to MMMFs

catering only to institutional investors was funds that otherwise would have
been invested in assets not included in M2.

In addition, it seems likely

43
-II-

that a small portion of the $90 billion growth in other types of MMMFs also
reflected diversions from assets not in M2.
In light of the sizable distortions created by the growth of institution-only MMMFs, M2 has been revised to exclude such funds but they will
continue to be a component of M3.
retail RPs.

In addition, M2 has been revised to include

Retail RPs, which previously had been a component only of M3,

were promoted on a substantial scale in 1981, likely attracting funds mainly
from household small time deposits and MMMF holdings and thus resulting in a
downward bias on M2 growth.

The net effect on M2 growth of reclassifying

institution-only MMMFs and retail RPs, along with other minor revisions, was
small.
M3 increased more rapidly than M2 last year largely because of the
substantial expansion in large CDs, particularly over the first half of the
year.

With growth of core deposits weak on balance over the year, depository

institutions increased their managed liabilities to support expansion in
loans and investments.
Bank credit growth accelerated somewhat in 1981 but stayed just
within the upper end of its annual target range.
growth was concentrated in business loans.

The pick-up in bank credit

Growth in this category was bol-

stered by the high level of corporate bond rates through most of the year,
which tended to focus business credit demands on short-term borrowing such as
bank loans and commercial paper.

Although merger activity contributed signifi-

cantly to the growth of loan commitments over the year, actual takedowns for
this purpose influenced loan growth only slightly.

Real estate loans at banks

in 1981 grew at about the same moderate pace as in the prior year, while

44
-13-

consumer lending strengthened a little from 1980.

Security holdings at banks

grew somewhat more slowly than loans in 1981.
The bank credit data in December were affected by the shifting of
assets to accounts in the newly authorized International Banking Facilities
(IBFs).

It is estimated that about $22 billion of loans to foreign customers

were shifted from U.S. offices to IBFs in December.
report are adjusted for this shift.

The data presented in this

Without this adjustment, the increase in

bank credit from the fourth quarter of 1980 to the fourth quarter of 1981 was
8-1/4 percent, one-half percentage point less than shown by the adjusted
data.
Broader measures of credit flows reflected the slowing pace of production and income in 1981 and the effects of high interest rates.

Households

and businesses continued to increase their borrowing over the first three
quarters, but their use of credit contracted in the fourth quarter in response
to the weakening of the economy.

In view of the high level of long-term

interest rates during most of 1981, virtually all of the increase in funds
raised was in short-term debt instruments.

Overall, net funds raised by

nonfinancial sectors rose 7 percent in 1981 and continued to fall relative
to GNP for the third consecutive year.

45
-19-

Section 3;

The Federal Reserve's Objectives for the Growth of Money and Credit

The Federal Reserve remains committed to restraint on the growth of
money and credit in order to exert continuing downward pressure on the rate of
inflation.

Such a policy is essential if the groundwork is to be laid for

sustained economic expansion.
There was a distinct slowing of inflation during 1981, and the prospects for further progress are good.

Failure to persist in the effort to

maintain the improvement would have long-lasting and damaging consequences.
Once again, underlying expectations would deteriorate, with potentially adverse
effects on financial markets, particularly long-term rates.

The result would

be to embed inflation even more deeply into the nation's economic system—with
the attendant debilitating consequences for the performance of the economy.

failure to continue on the current path would mean that the next effort would
be associated with still greater hardship.
Progress toward price stability can be achieved most effectively
and with the least amount of economic disruption by the concerted application
of monetary, fiscal, regulatory and other economic policies.

But it is quite

clear that inflation cannot persist over an extended period unless financed
by excessive growth of money.

Thus, a policy of restraint on the growth of

the monetary aggregates is a key element in an anti-inflation strategy.
Targets for the monetary aggregates have been set with the aim of
slowing the expansion of money over time to rates consistent with the needs
of an economy growing in line with its productive potential at reasonably
stable prices.

The speed with which the trend of monetary growth can be

lowered without unduly disturbing effects on short-run economic performance
depends, in part, on the credibility of anti-inflation policies and their

46
-20-

effects on price expectations as well as on other forces influencing interest
rates and credit market demands, including importantly the fiscal position of
the federal government.

More technically, financial innovation or other fac-

tors affecting the demand for specific forms of money need to be monitored.
In its deliberations concerning the target ranges for 1982, the
Committee recognized that the recent rapid increase in Ml placed the measure
in January well above the average level during the fourth quarter of 1981, the
conventional base for the new target.

Experience has shown that, from time to

time. 111 growth can fluctuate rather sharply over short periods, and these
movements may be at least partially reversed fairly quickly.

The available

analysis suggested that the recent increase reflected in part some temporary
factors of that kind, rather than signalling a basic change in the amount of
money needed to finance nominal GNP growth.
In the light of all these considerations, the FOMC reaffirmed the
following ranges of monetary expansion—tentatively set out in mid-1981—for
the year ending in the fourth quarter of 1982:

for Ml, 2-1/2 to 5-1/2 per-

cent; for M2, 6 to 9 percent, and for M3, 6-1/2 to 9-1/2 percent.1

The FOMC

also adopted a corresponding range of 6 to 9 percent for commercial bank
credit.

These ranges are the same as those agreed to in July and reaffirm the

1. The objective for growth of narrowly defined money over 1982 is set in
terms of Ml only. Last February, when the FOMC set its targets for narrow
money, it was recognized that regulatory changes allowing for the establishment of nationwide NOW accounts would distort the observed behavior of Ml-A
and Ml-B. Accordingly, the targets were set on a basis that abstracted from
the shifting of funds into interest-bearing checkable deposits. Based on a
variety of evidence suggesting that the bulk of the shift to NOW accounts had
occurred by late 1981, the Federal Reserve reaffirmed in December its previously
announced intention that starting in January 1982 shift adjustments would no
longer be published and only a single Ml figure would be released with the
same coverage as Ml-B.

Federal Reserve's commitment to reduce inflationary forces.

As has been

typical in the past, these changes are measured from actual fourth quarter
levels from the previous year.^
During 1981, Ml-B (shift-adjusted) rose relatively slowly in relation to nominal GNP.2

On the assumption that the relationship between growth

of Ml and the rise of nominal GNP is likely to be more normal in 1982, and
given the relatively low base for the Ml-B range, the Committee contemplated
that growth in Ml this year may well be in the upper part of its range.

the same time, the FOMC elected to retain the 2-1/2 percent lower bound for
Ml growth tentatively set last July in recognition of the possibility that
financial innovations—especially techniques for economizing on the use of
checking account balances included in Ml—could accelerate, with restraining effects on Ml growth.
The actual and potential effects on Ml of ongoing changes in financial technology and the greater availability of a wide variety of money-like
instruments and near-monies strongly suggest the need for also giving careful
attention to developments with respect to broader money measures in the implementation of monetary policy.

The range for M2 growth is the same as in 1981

when actual growth slightly exceeded the upper bound of the range.

The Com-

mittee contemplated that M2 growth in 1982 would be somewhat below the 1981

1. Because of the introduction of International Banking Facilities, the bank
credit data after December 1981 are not comparable to earlier data. Thus, the
targets for 1982 are in terms of growth from an average of December 1981 and
January 1982 to the average level in the fourth quarter of 1982.
2. Ml-B velocity, before shift adjustment, rose at a rate closer to historical
experience. However, the shift of funds from savings accounts or other sources
of funds not included in measures of the narrow money supply temporarily
depressed that velocity figure, particularly early in the year.

48
-22-

pace, although probably In the upper part of the range.

However, should per-

sonal saving, responding to recent changes in tax law or other influences,
grow substantially more rapidly in relation to income than now anticipated,
or should depository institutions attract an exceptionally large inflow to IRA
accounts from sources outside measured M2, growth of M2 might appropriately
reach—or even slightly exceed—the upper end of the range.

The ability of

depository institutions to compete for the public's savings will, of course,
also be affected in part by deregulatory decisions that may be made by the
Depository Institutions Deregulation Committee.
The 1982 ranges for M3 and bank credit were left unchanged from
those for 1981.

These aggregates again will be influenced importantly by

the degree to which credit demands tend to be focused on short-term borrowing
and are funded at home or abroad.

49
-23-

Section 4;

The Outlook for the Economy in 1982

Economic activity still appears to be contracting; industrial production and employment certainly declined further in January, with the extent
of the fall worsened by exceptionally bad winter storms.

Demand in the key

sectors that had led the decline—housing and consumer spending—showed some
signs of leveling off as the year began, and the recent cuts in production
likely have helped to relieve some of the remaining inventory imbalances.
Recent weather-related disruptions may affect the incoming data for a time,
but it would appear that the economy is in the process of bottoming out, and
a perceptible recovery in business activity seems likely before midyear.
One element supporting final demands in the economy is the federal
government.

Part of the recent expansion in the deficit reflects the cushion-

ing effects of reduced taxes and increased government expenditures that result
from declining income growth and rising unemployment.

In addition, however,

the build-up in defense spending is a continuing source of stimulus.

The

second phase of the tax reductions that occurs in July will provide another
expansionary impetus to the economy.

At the same time, the deficit—particu-

larly if expected to continue at exceptionally high levels in later years—
adversely influences current financial market conditions.
The Federal Reserve's objectives for money growth in 1982 are consistent with recovery in economic activity.

The expansion is likely to be

concentrated initially in consumer spending.

Given the substantial margin

of excess capacity, outlays for business fixed investment may remain weak,
particularly if long-term interest rates continue to fluctuate near their
current high levels.

A continuation of high levels of long-term rates also

50
-24-

would inhibit the recovery in residential housing, although demographic factors will continue to buttress demands in that sector.
The effort to deal with inflation is at a critical juncture.

The

upward trend in inflation clearly has been halted and the process of reversal
is underway.

There are signs that price setting, wage bargaining, and per-

sonal spending decisions are beginning to be made that over time will serve
to moderate, rather than intensify, inflationary pressures.

Nonetheless, the

behavior of financial markets and other evidence strongly suggests that there
continues to be considerable skepticism that progress in reducing inflation
will be maintained.

Lasting improvement in financial markets—particularly

for longer-term instruments—is dependent on confidence that progress against
inflation will continue; looming federal deficits have served to shake that
confidence.

Prospects for lower interest rates and for sustaining recovery

over a long period—indeed for the timing of recovery—are thus tied to prospects for a more stable price level.
How we emerge from the current recession will be crucial to further
curtailing inflation.

The recovery phases that have followed recent reces-

sions have sometimes been associated with an acceleration of inflation.

How-

ever, if monetary and fiscal policies are appropriately disciplined, this
pattern need not recur; and recovery from the current recession will be consistent with further progress towards achieving sustainable growth, price
stability, and lower levels of interest rates.
Given the current circumstances and in light of the monetary aggregate objectives for the coming year, the individual members of the FOMC have
formulated projections for economic performance in 1982 that generally fall

51
-25-

within the ranges indicated in the table below.

The members of the FOMC

expect inflation to continue to moderate in 1982.

At the same time, real

activity is expected to accelerate with most of the growth coming in the
second half of the year.

With inflation continuing to be substantial and the

prospect of the federal budget deficit remaining large even as the recovery
gathers momentum, demands for credit should intensify as the year progresses.
In these circumstances, the recovery is likely to be somewhat restrained,
with the result that unemployment probably still will be substantial at
year-end.

Economic Projections for 1982

Actual 1981

Projected 1982
FOMC members
Administration

Changes, fourth quarter to
fourth quarter, percent
Nominal GNP
Real GNP
GNP deflator

9.3
0.7
8.6

8 to 10-1/2
1/2 to 3
6-1/2 to 7-3/4

10.4
3.0
7.2

8.3

8-1/4 to 9-1/2

8.4

Average level in the
fourth quarter, percent
Unemployment Rate

The FOMC member's projections generally encompass those that underlie the Adminstration's recent budget proposals.

The consensus view of the

FOMC anticipates an improvement in inflation during 1982 comparable with the
Administration's as well as a similar outlook for the labor market.

The

Administration's projection for real growth falls at the high end of the
FOMC consensus.

If, in the event, prices and wages should respond more

rapidly to anti-inflation policies than historical experience would suggest
or should more favorable productivity trends develop, then the recovery
could be faster without adverse pressures developing on prices, wages, and
interest rates.

Chairman VOLCKER. You addressed a couple of questions to me,
Mr. Chairman. Let me just briefly respond.
You note, I think, that the actual unemployment in 1981 was
above the range in the forecast we gave you. It looks to me like 1it
was only above the range by rounding a number—8.3 instead of S A
percent and that reflected a pretty close estimate.
I don't think the projections we give this year at all mean we
should expect unemployment to be around 10 percent in 1982. The
projections are lower than that, and that's what we anticipate.
You raised a question about where the Federal Reserve stands
with respect to the administration's program, which has several
elements, as you know, in terms of monetary policy. In terms of
general direction and substance, as we have both said, my understanding is that we see things in a parallel way. The Federal Reserve, I think, in general sees benefits accruing from action on the
regulatory side of things; we can help productivity and reduce costs
by progress on regulation, a point the administration has emphasized.
I do believe the tax policy can be important, as I emphasize in
my statement, in terms of productivity, and growth and incentives
over time. The issue which we have emphasized all along is reconciling that tax action, which can be constructive, with a budgetary
outcome that does not, by working in the other direction, make the
job not only of conducting monetary policy but of bringing down
interest rates and setting the stage for recovery much more difficult.
I think the issue is the deficit spending—the combination of revenues and spending. You have before you a budgetary document
submitted by the President which proposes some very major measures, as you know, to bring that deficit down to a level that will be
more tolerable than permitting a deficit in the neighborhood of
$150 billion as projected for next year to materialize. The administration has proposed some very large steps in that direction.
The CHAIRMAN. How about the administration's projections on
the 3-month T-bill rates, to wit: 11.7 in 1982; 10.5 in 1983; and 9.3
percent in 1984? Do you agree with those projections?
Chairman VOLCKER. I don't agree or disagree. I don't have great
faith in my ability to project precise levels of interest rates in the
short run or in the long run. I think their projections do reflect,
historically, relative to the inflation rate—just to use that as a
benchmark—and, in general, a relatively high level of interest
rates.
The feasibility of having that declining trend or doing better, I
think, rests in very substantial part on the deficit question that we
have referred to.
The CHAIRMAN. Therefore, a lot of iffiness as far as those projections.
Chairman VOLCKER. There's bound to be a lot of "iffiness" in any
interest rate projection. But I think the kinds of measures that
need to be taken to maximize the chances for low interest rates are
quite clear.
The CHAIRMAN. Chairman Volcker, in the state of the Union address, the one point that the President pointed to with pride was
the rate of inflation as measured by the CPI. Inflation declined

more than 3 percentage points in 1981 to 8.9 percent. That reduction, however, was only partly due to the economic program that
was adopted.
It seems to be commonly agreed that energy and food prices, over
which none of us had any real control, rose less than expected, due
to the oil glut and to record harvests. Home sale prices, depressed
by high interest rates, did the rest.
Now my question to you is this: now that that's secured, I don't
think we can look forward to more of that. And in order to bring
inflation down even further in 1982, how many American citizens
are going to have to look forward to sacrificing in the form of unemployment?
Chairman VOLCKER. I allude to this point, of course, in my statement. You are quite right; I don't think we can pick out oil prices
or even food prices and say they're entirely removed from general
economic policy, but there are special factors at work. I think more
generally it is quite true that the degree of progress on prices at
the moment reflects, in part, the fact that the economy is in recession.
You can't succeed in dealing with inflation over time by having
an economy in recession. You want an economy in growth. What is
important, therefore—and what I would emphasize—is that we
build on this effort to deal with inflation, on the clear signs of progress we see, and convert that into a platform for building a lower
rate of cost increase into the economy—the kind of thing that can
last.
We begin to see that going on. But that comes more slowly than
the immediate effects you get from the special influences that you
mentioned or from high interest rates or weak markets in so many
areas. But I think we are beginning to see the process at work,
with a lower rate of inflation, from whatever cause, in the short
run beginning to be built into the wage and cost structure.
I think we see business and labor together turning their attention, quite properly, not only to restraint on the wage side, but to
measures that will improve productivity over time, which is very
basic to continuing to wind down the inflation rate while the economy expands.
The CHAIRMAN. My question, Chairman Volcker, was—and it's
the question, I think, in the minds of most American people
today—it seems to be more important to the American people now
than the rate of inflation—and that is unemployment. How many
unemployed must be looked forward to during 1982 to keep bringing down inflation?
Chairman VOLCKER. We gave you some projections for 1982.
The CHAIRMAN. You gave us some projections; yes.
Chairman VOLCKER. We have an economy which, while it is not
perfectly clear, is probably still declining. I am sure the February
figures will reflect that, because of the weather, if nothing else. We
have an unemployment rate which was 8.9 percent in December. It
moved, probably flukishly, lower in January. We are going to have
a high level of unemployment this year, reflected in our own projections and the projections of others. But we think the prospects
are good for some economic recovery beginning before midyear.
The CHAIRMAN. Mr. Stanton.

Mr. STANTON. Thank you very much, Mr. Chairman.
Mr. Chairman, I would assume that the administration will find
a lot to applaud in your statement. There are a few things I presume they won't.
It seems to me that the targets that the Secretary of the Treasury was hoping for, especially in Mi, were about the same as what
you announced. The differences seem to be in the fluctuation of the
money supply, and this, of course, is something that has been going
on since October 1979.
The first question to you: Should we look forward to the same
money supply fluctuations this year as we have seen in the last 6
months, or is there any chance or hope for improvement in that
and, if so, why?
Chairman VOLCKER. I think we will see fluctuations. I think that
is the nature of the beast. Let me say I think this is a matter that,
to my mind, for good and sufficient reason, has not been much emphasized in the past—this kind of emphasis on monthly or even
quarterly fluctuations.
The studies that we have done of the matter and, I think, the
studies of which I am aware that most other people have done on
the matter suggest that the fluctuations are not significant to economic activity or the general course of interest rates or, certainly,
inflation. You wouldn't know it from listening to some of this discussion, but we happen to have, in Mi, about the most stable
money supply in the world.
I have looked at a lot of other industrialized countries and about
the only one that I find that compares in terms of stability is Italy.
The trend in Italy happens to be a little different. It goes up about
20 percent a year, but it's relatively steady around that trend.
Let me give you some figures for some other countries. You could
look at monthly numbers or I could give you quarterly numbers.
Canada had a month last year when the money supply went down
at an annual rate of 40 percent. They had a month in which it
went up at an annual rate of 87 percent. We have these self-inflicted wounds from looking at everything in terms of annual rates, so
Til give you the figures for other countries in terms of annual
rates.
Germany had a month where money went down at an annual
rate of 32 percent and one where it went up at an annual rate of
17 percent. Japan, often pointed to as having remarkably good
monetary policy recently, had a month where the figure went down
by 44 percent at an annual rate, and a month where it went up at
an annual rate of 93% percent—and I want to get that % percent
in there.
Switzerland's figures varied between minus 42 and plus 14. We
had a month where Mi went
up at an annual rate of 19 M> percent,
meaning it went up about ll/2 percent that month; we had 1 month
where it went down by an annual rate of 10 percent, meaning it
went down by less than 1 percent in that month. So I don't want
you to think of this as a phenomenon of the United States. In the
international league, we have a relatively stable money supply,
and I must confess I find my foreign central banking colleagues—
they may all be wrong—constantly expressing some degree of con-

cern and dismay a|s to why we worry so much about the short-term
fluctuation.
You have a checking account and it doesn't remain absolutely
steady from month to month, I presume. I am not sure you would
want us to compel you to keep it absolutely steady from month to
month.
We are, in effect, dealing with a checking account for a large
portion of the world. We have a money supply of about $400 billion.
There are about a half trillion dollars a day of transactions around
the world and I think it's a question of whether the world's checking account is going to come out precisely stable from month to
month any more than your checking account is going to come out
precisely stable from month to month, or even whether it would be
desirable to enforce that rigidity on the system.
The other side of the coin would be that if you tried to keep it
stable, interest rates would fluctuate much more greatly than they
do in the short run, and I'm not sure that that is the result that
anybody would really like to see.
What is important is that we maintain a trend toward restrained
growth and lower growth, and I am satisfied our record shows that.
Mi has come down an average of about 1 percent a year for the last
3 years, looking at the average growth from year to year.
The CHAIRMAN. Mr. Gonzalez?
Mr. GONZALEZ. Thank you very much, Mr. Chairman.
Chairman Volcker, I think it impelling on my part to report to
you that the fears, I am sure, that have obsessed you should be allayed with respect to my impeachment resolution. I had a letter
from Chairman Rodino in which he indicates that he can't proceed
on that for the immediate future. He says they have got so much
business—and I hope I don't let the cat out of the bag—but maybe
they are working on impeachment on the President—but they
can't entertain it at this time. However, I intend to proceed in absentia on the House floor.
My question is: If President Reagan is right and if you are so
right, why is the stock market in such a state of hysteria? Why are
the bond markets collapsed? Why is investment down? Where is all
the confidence and growth that was supposed to come out of
"Volckernomics"?
The results so far have been re-Volckering. You know, this is
what the business constituencies ask, and how do you answer that?
If your course of action over these 3 years and everything is so
dead right, why this condition?
Chairman VOLCKER. Let me note that the Federal Reserve is responsible for monetary policy, not anything else. But let me also
emphasize that I think the basic answer to your question is that we
are in an extremely difficult period of time. We have some extremely difficult economic problems that have accumulated over a
long period of time.
I don't think you can point to any statements of mine that suggested that this would be anything but a difficult period in terms of
turning some of those trends around. We are seeing that, unfortunately, in spades. I think we can also see some developments
moving in a potentially constructive way.

I think we are taking steps and have taken steps to lay the base
for a much brighter future, as I tried to outline in my statement.
Mr. GONZALEZ. But, Mr. Chairman, by every accepted definition
the administration is following a loose fiscal policy and you are
pursuing a tight or restrictive monetary program. In other words,
the President is pushing on the gas pedal and you're standing on
the brakes. Why do we have this contradiction, this conflict?
Do you think the President's program is irresponsible or is it the
other way around?
Chairman VOLCKER. I think the way you meet that problem, Mr.
Gonzalez, is by attacking those potential budgetary deficits that sit
out there. I think you quite accurately point to an actual and potential problem. The President has outlined a program. If you ask
me, I would be even more delighted if you succeed in taking budgetary actions that reduce the deficit even further than he has suggested, but he has certainly put a large menu on the table and you
can pick and choose, I suppose, the way to do it. But I think it is
important to move to get that deficit down so the potential contradiction, if you will, that you referred to is alleviated.
Mr. GONZALEZ. Mr. Chairman, for instance, yesterday in emergency the House passed overwhelmingly a $1.8 billion appropriation as an emergency measure because of unemployment and because of the action just taken last December, in obedience to your
recommendations, the President's recommendations.
The President came in and said we had to have $1.5 billion more
in foreign aid, when he ran all over the country assaulting the
Carter administration, the Democrats, and the likes of me as
spenders because we had been supporting that program. Now, how
in the world with this contradiction can we reconcile this?
Chairman VOLCKER. Let me make one point regarding timing.
What I am talking about in terms of the threat of deficits, the kind
of threat that you referred to, is primarily a problem for 1983 and
1984 and the years beyond. It is the potential collision between the
investment needs for and during a period of recovery and the continuing, rising budgetary deficits that is the problem.
.While I am not suggesting at all, obviously, opening up the
spending taps now, your concentration in terms of dealing with the
budgetary problem seems to me properly focused on 1983 and 1984.
That's where the large, exceptionally large, deficits loom. The deficit this year, if it were not for the recession, would be very substantially smaller.
What concerns me and concerns a great many people is the fact
that those deficits would increase during a period of recovery when
you have the potential problem in the financial markets. The problem that we are struggling with now is that that potential problem
for 1983-84 is reflected back in the market today and, indeed, is a
major obstacle to getting the recovery started in the first place.
Mr. GONZALEZ. Thank you very much.
The CHAIRMAN. Mr. Wylie?
Mr. WYLIE. Thank you, Mr. Chairman.
Chairman Volcker, I want to congratulate you for an excellent
statement and for the work you and the Federal Reserve Board
have done in contributing to the progress this country is making in
lowering the rate of interest and lowering inflation. I think you are

on target on what you are doing, and that you have also been the
target of a considerable amount of criticism which you don't deserve for high interest rates and unemployment.
As you know, I have spent several years suggesting that the
number one problem in this country is inflation and I am still committed to the process of reducing further the size of the federal
deficits to manageable proportions, as being necessary to bring
down inflation and interest rates. I agree with you on that, Mr.
Chairman.
At some future time, most economists expect that the business
conditions will improve. They are suggesting that by midyear business conditions will improve. Do you agree with that assessment?
Chairman VOLCKER. I would generally agree with that assessment. I don't think anybody's forecasting record is all that brilliant
in recent years. But I would agree with the assessment that that is
the probability.
I think there are clearly risks in the situation and I would
simply come back to the point that, since so many of those risks
are bound up in what happens in financial markets, the greatest
contribution the Congress can make to minimizing those risks and,
indeed, to enhancing the prospects for early recovery—and without
doubt enhancing the prospects for sustaining the recovery—is to
deal with this budgetary problem.
Mr. WYLIE. OK. If business conditions improve, this would presumably lead to increased demand for money, an increased demand
on money markets by firms and individuals. Have you made projections in that regard? How do you visualize Fed money policy if that
point arrives?
Chairman VOLCKER. I don't know how far ahead we have projections. The staff is constantly examining different possible outlooks
in that respect.
Let me say that th& early stages of recovery do not necessarily
bring heavy credit demands. It depends on how profits evolve and a
number of other things. But certainly, over time, recovery would
bring greater credit demands, greater need for investment.
We have the homebuilding industry depressed, and that is a very
clear area of need. The homebuilding industry and the home
buying public chews up enormous amounts of credit when it is in a
strong position. It's not doing that now because it is so depressed,
but we don't want it so depressed. And it is quite clear that that
industry alone would lead to very large additional demands for
credit.
That is simply another way of saying let's get the Federal
demand for credit out of the way so there's room for that private
demand.
Mr. WYLIE. So you are taking that into account?
Chairman VOLCKER. We are indeed.
Mr. WYLIE. You mentioned earlier the fluctuations in checking
accounts as making it difficult for you to determine what the
money supply might be. On page 14 of the Federal Reserve's monetary policy report which just came out this week, there is a table
giving the growth rates of monetary aggregates during the last 4
years.

Roughly speaking, Mi B has been increasing at a decreasing rate,
while M 2 has been increasing at an increasing rate. Now money
market mutual funds are in M2.
Chairman VOLCKER. Correct.
Mr. WYLIE. Many of our constituents are writing checks against
their deposits in their Mi B accounts and buying money market
mutual funds, which puts them into M 2 right away.
Chairman VOLCKER. That's right.
Mr. WYLIE. Now many of these money market mutual funds in
turn permit checks to be drawn for payments to third parties,
which makes them a lot like MiB. I am one of those who suggested
that perhaps you ought to have the authority to place a reserve requirement on those accounts. Would that help you in the conduct
of monetary policy?
Chairman VOLCKER. Yes; I think it would be of some assistance.
We made some proposals before this committee 9 months ago or so
suggesting that we don't have to put reserve requirements against
the whole of money market funds, but at least against that portion
that is used, in effect, as a substitute for checking accounts and
would be like the kind of accounts in Mi.
I might note that I think you get a better idea of the trend from
the bottom part of the table, you refer to which has annual averages and reflects the steady downward progression in Mi. It shows
not a steady upward progression in M2 but a fairly stable picture—
actually a slightly declining picture, until last year, when it did go
up.
I think those divergent trends are illustrative of exactly the
point you are making. Money market funds are included in M2,
and that is one factor that, for structural reasons, has tended to
keep M 2 up, particularly last year, when the growth was so explosive; some of that money comes from funds outside of M2.
To the extent there is a shift from areas outside of M2 into M2,
we should allow for that. Some of it comes out of Mi, and we
should allow for that, too, and we try to in our operations.
It may be of interest to the committee that we have examined
this, obviously, as closely as we can. The proportion of money
market funds accounts that is used actively as checking balances is
still small, but the funds have been growing rapidly, of course; we
have various estimates that the impact on Mi may have been between roughly 1 and 3 percent—in that area—last year.
Mr. WYLIE. Some of my colleagues are saying that you should increase the rate of increase in the Mi B by urging you to expand reserves through open market purchases of Government securities.
Would you care to comment on that and then my time has expired.
Chairman VOLCKER. I don't believe we should. Our policy is
gaged at maintaining a growth in Mi that we feel appropriate to
this job of bringing down the inflation rate over time, and we believe the target this year would also allow for the kind of recovery
that's been projected during this time period.
Mr. WYLIE. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Minish?
Mr. MINISH. Thank you, Mr. Chairman.
I am pleased to welcome my former constituent, and I want to
say, Chairman Volcker, you are the best drawing card that this

committee has had in the 20 years that I have been on it. They are
standing out in the hall, and I suppose if you could charge admission it would help you decrease the deficit, but of course we can't
do that.
You know, I want to make a couple of comments. I don't know
where people shop when they say that food prices are going down,
but let me assure you in the area that the chairman himself lived
in, all you have to do is walk into a supermarket—and I do that
with my wife, on occasion—and I am besieged by at least 10 or 15
people asking me, "What's this about food prices going down?"
They're not going down. I think you can ask anyone out there, but
at least in New Jersey they're not going down.
On the question of
Chairman VOLCKER. They are a little more stable than they were
anyway, Mr. Minish; that's what the figures show.
Mr. MINISH. Well, I don't know what your level of "stable" is.
Chairman VOLCKER. We still have inflation.
Mr. MINISH. Fine. OK, inflation is cut down, and on page 5 in
your statement you talked about the impact that homes—houses—
have on inflation. Homes have not really come down in price, as I
see it, and still there is an increase in inflation, which means, to
me, if I interpret it properly, that homes now take a bigger portion
of the inflation rate than they did prior to inflation coming down.
Chairman VOLCKER. Home prices are very difficult to measure.
The measurements that we have are subject to a lot of reservation.
Generally, they show some leveling off in home prices, but some
continuing increase. Those figures do not take account of the fact
that so many homes now are sold under special financing arrangements that, in effect, decrease the price of the home.
If one allows for that, it may be that prices are declining. But, in
general, the data suggest that they are much more stable than
they were. I think you are right that the data don't show absolute
declines, not over any period of time, anyway.
Mr. MINISH. What do you foresee for the future of the young
people that would like to own a piece of America by owning their
own home?
Chairman VOLCKER. That's more difficult now than it was before.
You know that. It's more difficult for two reasons, I would emphasize. Not only are interest rates extraordinarily high now, but, as I
noted in the statement, the price of a home relative to everything
else is higher. That is a situation which one would expect to be corrected, at least in part. You are not going to correct, probably, for
the fact that land becomes increasingly scarce, and that's a factor
in prices. But prices are part of the whole inflationary process, and
as we are successful we would foresee the lower interest rates.
There is a great deal of activity in the homebuilding industry, a
great deal of thinking and planning in the homebuilding industry—I think I can testify from some firsthand exposure recently—
toward building smaller houses, building houses more efficiently,
which moves in the direction of addressing the very problem you
mention.
The typical home got quite a lot bigger over the last decade. I
think builders are finding ways of returning to a somewhat smaller

size house, to a different kind of planning, a different kind of land
use, and all the rest, reflecting adaptations to this problem.
Mr. MINISH. Of course, I know you are fully aware of the problems with the thrift industry, particularly up in the Northeast,
where many of them are having liquidity problems. Has the Federal Reserve given consideration to this plight, because this really is
the industry that provided the mortgage money for the average
family.
Chairman VOLCKER. We give consideration to that problem constantly. It is an extremely difficult problem. The only really satisfactory solution is to get lower interest rates. That is the only thing
that will bring them back to real health—that and the passage of
time—is the only kind of basic solution. But we have addressed
ourselves to this problem repeatedly.
As you know, we presented some legislation to deal with it in a
very short-term context, which this committee passed and the
House as a whole has passed. It seems to me unfortunate it has not
passed the entire Congress. It is not a complete answer to the problem by any means. It is a means of coping with some of the immediate stresses more efficiently.
There is discussion of broadening the powers of the thrifts, but
that is more a long-term matter than a short-term matter. There is
a very great problem in that industry. It has affected our ability to
deregulate deposit rates, for instance. We have moved more slowly
on that issue than otherwise would be desirable because of the
need to avoid further pressures on that industry in an already very
difficult situation.
Mr. MINISH. Well, notwithstanding the need for the legislation, is
there anything that the Fed is doing or can do to alleviate some of
these problems?
Chairman VOLCKER. We are prepared to and do lend to them
when they have longer term liquidity problems or when they have
short-term liquidity problems. But the basic problem that they are
coping with is not a liquidity problem. Most of those institutions
have ample liquidity. In fact, their liquidity tends to be higher now
than it has been historically. The problem is an earnings problem
and the Federal Reserve does not have the tools to deal with an
earnings problem.
Mr. MINISH. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Hansen.
Mr. HANSEN. Thank you, Mr. Chairman.
As the ranking minority member for the Domestic Monetary
Policy Subcommittee, I am pleased to join in welcoming you, Chairman Volcker, this morning, and I have been most interested in
your presentation on behalf of the Federal Reserve Board.
Mr. Volcker, the conclusion of your statement is very strong.
There is really nothing very new that can be said or asked at this
time which I and others of this committee have not voiced over the
past several years at similar hearings. However, in view of pur current economic crisis, I want to preface two key questions with a rehearsal of several concerns, some of which have been addressed in
your statement. And, as you are well aware, this is important because the Federal Reserve, the White House and the Congress are
under increasingly heavy fire by nervous citizens demanding action

and answers, not more economic jitterbugging and buckpassing, as
they do often term it.
Now, Mr. Volcker, first, I think it is time for the President, the
Congress and the Fed to clearly stake out their areas of responsibility and take action. It is important that you reassert, as you have
done recently, that the Federal Reserve System cannot adequately
compensate, with manipulation of money policy, for problems created by several decades of irresponsible fiscal policy.
Frankly, it is difficult for me to see how monetary policy can succeed in its goals unless the current Congress will continue to make
significant cuts in spending and reduction in Government waste, as
you have suggested this morning, and your meaningful input is
sorely needed on this issue.
Second, it is time for the Fed to get its act together and put an
end to the wild ride we have been on, getting on the money supply
and interest rate rollercoaster. It would be well if you could assure
us that you are aggressively working on a more accurate system of
operations which will allow you to function within your monetary
supply target range and avoid the wide variances we have discussed in the past.
Much of the hesitancy and distrust in the markets is obviously a
result of some concern as to whether the Fed can assess the day-today money markets accurately enough to respond in a way which
will accomplish the monetary policies you are trying to implement.
And I didn't find too comforting your analysis of the individual
checking account compared to the worldwide checking account, so
to speak, because I would hope that there would be more stability
in an overall situation than on an individual basis.
Third, it is time to do what must be done for the relief of the
hard-pressed economy without further delay. And this may be less
direct, but I am getting a tremendous amount of mail from my constituents, and particularly small businesses who have been willing
to sacrifice if it would help in the long run. But they are getting
into a time frame which now they consider to be "the long run/'
and a great many are being pushed to the brink of bankruptcy as a
result of the continuing high interest rates.
This persistence of high interest has now spanned two administrations and they are blaming you and your organization more
than anyone else for this dilemma. Because so much depends on
the Fed, I am trying hard to defend you and the monetary policy
you are attempting to implement, but time is running out, and
these people need help immediately.
These are not the marginal businesses which failed 2 years ago
when interest rates first doubled and then tripled. These are the
long-time family businesses which have prospered over the years
and are now scraping the bottom of the barrel as they have dipped
into their accumulated earnings, reserves, and resources to survive.
There will not be many locally owned businesses left in my district
or anywhere in the Nation, I believe, if we don't see some meaningful signs of a turnaround soon.
I suspect that a little more confidence in the Fed's programs and
the accuracy of their methods and procedures would go a long way
toward providing the kind of assurances to set a lasting downward
trend in the interest rates, giving my constituents and the money

markets sufficient encouragement to make some long-range plans
and commitments.
Now in this regard, Mr. Chairman, on page 24 of your report you
state the effort to deal with inflation is at a critical juncture. And
after noting some encouraging signs in the fight against inflation
you continue, and I quote: "Nonetheless, the behavior of financial
markets and other evidence strongly suggests that there continues
to be considerable skepticism that progress in reducing inflation
can be maintained/'
Now I must ask to what extent do the actions of the Federal Reserve overshooting the targets for MiB growth in 1980, undershooting these same targets in 1981, allowing the money supply of Mi to
grow at roughly 17 percent for the last 3 months—how does this
contribute to market skepticism?
Chairman VOLCKER. It's all a matter of judgment, I suppose, Mr.
Hansen. I do not believe that is the major element in market skepticism.
Mr. HANSEN. Well, if credibility in dealing with inflation has to
be earned by performance and persistence, as you note on page 3 of
your statement, what else should or could the Federal Reserve be
doing to improve its own credibility in the market?
Chairman VOLCKER. I think if you look at the table Mr. Wylie
referred to, you will see a trend, in Mi growth particularly, that
shows a steady diminution which is what we have said we would
do. I think the record is pretty clear in that respect.
While you could find, I am sure, differing strands of opinion in
the market, I think there is general recognition of that in the marketplace. We would love the money supply to be perfectly stable
from month to month, and I think your point is quite correct; you
would expect the total to be more stable than any individual component thereof.
But these fluctuations are relatively small; we blow them all up
and speak of them in terms of annual rates, but they are relatively
small fluctuations. You are going to have some fluctuations from
month to month. I pointed out that they are characteristic all over
the world, and if you followed a technique to attempt to keep that
absolutely rigid—which is beyond our or anybody's capacity—I
think the tradeoff would be more instability in interest rates which
would probably be more upsetting to people than short-term fluctuations in the money supply.
When you build a building you permit it to bend a little bit in
the wind—and there are a lot of winds out there in the money
market—in the interest of the overall strength and the durability
of the whole. I think you can look at the money supply a little bit
that way.
When we have an abnormal fluctuation in demand—and there
are all of the characteristics of that in the recent few months,
where the increase is so heavily concentrated on one limited component of the money supply—you have to ask yourself whether
that is a temporary or a more lasting change.
If it is indeed temporary, then to force an adjustment very harshly to that change in the short run would produce a lot of money
market instability to no end.
Mr. HANSEN. As a followup to that question

The CHAIRMAN. I'm sorry, but the gentleman's time has expired.
Mr. HANSEN. Could I just get a yes or no answer?
The CHAIRMAN. Your time has expired. If you would like you can
stick around for another round.
Mr. Mitchell.
Mr. MITCHELL. It is good to see you always.
Chairman VOLCKER. It is good to see you, Mr. Mitchell.
Mr. MITCHELL. Your testimony is pursuant to the Full Employment and Balanced Growth Act of 1978. I just want you to recall
the many conversations about black unemployment that I have
had with you since you have been in your position. We have always
talked about full employment and the fight against inflation. We
have simply abandoned the attempt to do anything about black unemployment. Now that white America is increasingly unemployed,
we see that this is becoming the No. 1 problem in the Nation, unemployment not inflation. I think we will cure the unemployment
problem. I honestly do. We cannot have people unemployed forever.
But I would just like to go on record by stating that when the
white rate of unemployment is cured, there will be no cure for the
black rate. You have simply abandoned my people. I guess I just
have to live with that. That is the way America works, I suppose.
Now, I have some specific questions I would like to put to you.
You did an incredible thing in December and January; $1.5 billion
in new money came out, an increase of 16 or 17 percent. I said it is
incredible, and I am not judging that negatively. I am not putting a
negative or positive connotation on it. You explained why you increased Mi, which, by the way, is a very imprecise measure. We
should not even be fooling with Mi anymore because it is so imprecise.
It has been the general policy of the Fed once you shoot out a lot
of money like that in a period of time, 2 months, 3 months later
you go back and make adjustments. Most frequently, those adjustments have resulted in increases in interest rates.
Now, you have to make the adjustments in this period in which
you put out that much money, you have to make an adjustment
later on to stay within the parameters, the ranges that you suggest.
In short, then, what do you see are the precise implications for
this sudden influx of money, the sudden increase in Mi? Three
months from now, 4 months from now, will you be tightening it up
again?
Chairman VOLCKER. As I indicated, Mr. Mitchell, this recent increase has been heavily concentrated in one component of the
money supply.
Mr. MITCHELL. Yes.
Chairman VOLCKER. I am searching for the numbers here, but, as
I recall, money supply may be up $15 billion in the last 3 or 4
months
Mr. MITCHELL. Yes.
Chairman VOLCKER [continuing]. Of which about $9 billion is in
NOW accounts. This has some of the characteristics of a development peculiar to the circumstances that exist. You are quite right
in terms of the techniques we follow; we do not provide the reserves through our open market operations to support that kind of

increase, so you see a tightening in the money markets when you
get that kind of an increase. But it also has some characteristics—
although this will bear close watching—of a kind of development
that may be self-reversing, if you will, over a period of time. So I
would not want to jump to too strong conclusions on the basis of
the development, particularly in January; it is largely a January
phenomenon.
Mr. MITCHELL. All right. The point I am trying to make is,
though, and you are not going to answer the question because obviously you cannot, but will the adjustment exacerbate the present
economic problems that we are now having when you make the adjustment?
Chairman VOLCKER. Nobody is very happy about seeing the
money supply—more importantly in this case, interest rates—
rising at a time of recession.
Mr. MITCHELL. OK. I have one or two other questions, and I am
going to try to move quickly. I said Mi is a very imprecise measure.
Frankly, I would like to look at some other base, really.
Chairman VOLCKER. I would say it is better over a longer period
of time than when you look at it in a very short time period.
Mr. MITCHELL. Short time period. Yes. But now, the Federal Reserve publishes data on total reserves, the amount of total reserves,
but not on the amount of reserves held against Mi. Is that correct?
You publish your data on the total reserves.
Chairman VOLCKER. Right.
Mr. MITCHELL. But do you publish data on the amount of reserves held against Mi?
Chairman VOLCKER. No. You can make a computation of that. It
is a little bit technical because to the extent you have excess reserves, you do not know where to allocate them. But you can make
a calculation of the reserve requirement against Mi-type deposits.
Mr. MITCHELL. But it would seem to me that it would be awfully
important to publish that data. You see, there are different reserve
requirements against different types of financial assets
Chairman VOLCKER. Right.
Mr. MITCHELL [continuing]. As you know. When the public shifts
from a checking deposit, let us say, to a savings deposit or other
types of financial assets, this obviously causes a significant change
in the money supply. And it seems to me that it would be
Chairman VOLCKER. We try to compensate for that.
Mr. MITCHELL [continuing]. But it seems to me that it would be
prudent for you to publish your data on reserves held against Mi.
Chairman VOLCKER. Offhand I cannot think of any reason why
that cannot be done. We do make those kinds of computations internally, yes.
Mr. MITCHELL. Then I would make a very strong recommendation that, if possible, we start publishing that data so that too is
available to those who want to analyze the fluctuations in the economic system.
Do I have time for another question?
The CHAIRMAN. The gentleman's time is expired.
Mr. MITCHELL. My time has expired? Well, I had not even gotten
my rapier—well, OK, my time has expired.
The CHAIRMAN. Mr. Paul.

Mr. PAUL. Thank you, Mr. Chairman.
Mr. Volcker, I would like to follow up a little bit more on the
discussion on the rapid growth of the money supply in January. It
is my understanding that it did grow, Mi grew slightly faster, at a
rate of 19 percent.
When do you actually realize this? Do you realize this on January 1 or January 31, or do you realize it personally in the middle of
February? I am just trying to get a handle on how you know what
is going on.
Chairman VOLCKER. We collect the money supply figures weekly,
as you know. We publish them about as soon as we have a clear fix
on them, and those figures are subject to revision the following
week. We get some fragmentary data before we publish the numbers, but we do not have complete data until we publish them.
Mr. PAUL. Which is?
Chairman VOLCKER. We publish them on a Friday for the week
ending not the previous Wednesday, but the previous Wednesday
to that. Today is Wednesday; we will publish the figure for the
money supply for the week that is now ending a week from Friday.
Mr. PAUL. So there is no deliberate decision made by the Fed to
have a money supply growth of 19 percent?
Chairman VOLCKER. Of course not, no.
Mr. PAUL. And you only knew this after the fact?
Chairman VOLCKER. Virtually all of this came in the first week
of January, which we learned about a week later.
Mr. PAUL. So you only can make decisions after you have the information?
Chairman VOLCKER. That is correct.
Mr. PAUL. In other words, you cannot control the money supply?
Chairman VOLCKER. We cannot control the money supply on a
week-to-week basis, no.
Mr. PAUL. OK. I wanted to refer to the figures on table 1, where
I see that M3 exceeded your projected growth by approximately 2
percent. I know we do not deal with M3 very often, but I would just
like to pose a question to you that maybe this is somewhat deceptive, maybe there is a lot more money growth going on here than
anybody realizes, assuming that 2 percent, you might say that 2
percent is not all that bad, but 2 percent of over $2 trillion
Chairman VOLCKER. Yes.
Mr. PAUL [continuing]. Seems to be a lot of dollars. And if these
are in 30-day CD's
Chairman VOLCKER. Right.
Mr. PAUL [continuing]. We could very easily say this is liquid
capital
Chairman VOLCKER. Right.
Mr. PAUL [continuing]. And we are having a fantastic amount of
monetary growth.
Chairman VOLCKER. Exactly. That is why we look at all these figures. If I did not have an explanation for that overshoot, some of
your conclusions might follow. In fact, I think that figure last year
was somewhat distorted by two developments, one of which was the
technical way that figure is calculated; it includes domestic liabilities of banks and excludes certain foreign liabilities of banks, and
we had a mix of growth this year in banking liabilities that was

skewed toward the domestic issuance of CD's with a reduction in
their borrowings from their branches abroad. The way we compute
the figure, it gave what we think is an upward bias to the number
that does not have much economic significance. But if you look at
the broader aggregates generally—M2, M3, even L, which includes
all liquid assets—it does not reflect, you are quite correct, the
sharp diminution of monetary growth that you might conclude if
you only looked at MiB adjusted. That higher rate of growth in
those other aggregates was one reason we were willing to permit
Mi to run a little low.
Mr. PAUL. Then you would concede that if you took theoretically
the 2 percent excessive growth in M3 and this happened to end up
in Mi, we would have had a fantastic amount of monetary growth.
Chairman VOLCKER. That is right, because Mi is a small number.
Mr. PAUL. Right.
Chairman VOLCKER. But as I said, I think that is partly an artificial result, a statistical artificiality.
Mr. PAUL. A lot of our discussion so far has been on interest
rates, and there is justified reason for this, because when we go
and talk to the people, everything they see and hear about is in
terms of interest
Chairman VOLCKER. That is right.
Mr. PAUL. Because they cannot buy a house because of high interest rates.
On page 10 you recognize the fact that if you have an inflationary growth in the money supply with the attempt to lower interest
rates, this might even have a reversed effect and not necessarily
lower the interest rates.
Just for a moment, if we decided that your job was only to maintain interest rates at 10 percent and you had no other responsibilities as far as looking at what it would do to inflation and to the
economy, do you have the tools to literally create an interest rate
of 10 percent? Can you mechanically do that?
Chairman VOLCKER. No, I do not believe we could, Mr. Paul, certainly not for any length of time, and certainly not for all interest
rates, because if the results of that policy were to create great inflationary forces, you could not hold that 10 percent interest rate
for very long against all the forces in the marketplace.
Mr. PAUL. If you wanted to alter interest rates, what are your
tools? Is it the discount rate as well as the money supply, or mainly
the money supply?
Chairman VOLCKER. The discount rate can have some short-term
influence and will in many particular instances. A decision on the
discount rate will have some immediate effect on the money markets, but, over time, it is basically how much money you are
creating.
Mr. PAUL. What is the most significant factor in the high interest rates then? Is it the marketplace, the Congress, or the Federal
Reserve?
Chairman VOLCKER. It is a blend of all those things, and in different directions. Treasury financing is a major element in the
market uncertainty, I think, at the present time. We have a lot of
pressure, as is evident, on the money markets through a relatively
restrictive monetary policy relative to what the market would like

to borrow and the amount of money it would like to hold. That has
a short-run influence, tending to keep short-term rates in particular firm.
But when one looks at that in a longer term perspective, against
the inflationary consequences and outlook, as you yourself described better than I can describe, it has the opposite kind of effect,
so you are looking partly at what immediate short-term influences
are and judging that against what the influences are over a longer
period of time.
Mr. PAUL. Thank you, Mr. Chairman. My time has expired.
The CHAIRMAN. Mr. Fauntroy.
Mr. FAUNTROY. Thank you, Mr. Chairman.
Mr. Volcker, as you know, the administration is projecting a
nominal GNP growth of 9 to 11 percent over the next 5 years. And
over that period the Federal Reserve will presumably lower its
monetary targets by about a half of a percentage point each year.
My calculations show that velocity would have to grow at a rate of
at least 5 to 7 percent if GNP is to grow at the rate that the administration projects. And money supply is increasing at or below the
rate that you have targeted. Does that conform with your understanding? And are such rates of velocity possible?
Chairman VOLCKER. If you make those arithmetic assumptions,
yes, you get a very high rate of velocity.
Mr. FAUNTROY. All right. Inasmuch as velocity has increased
only an average of 3 percent over the last 20 years, does that not
historically anomalous high velocity rate suggest a basic flaw in
the administration's program and its economic projections?
I mean, if velocity does not increase that radically and the
growth of the money supply continues to slow, as slow as the administration wants it, does that not mean that economic growth
would be certainly below the levels projected by the administration
and that the deficits and the interest rate would be accordingly
higher?
Chairman VOLCKER. We have had a substantial reduction in Mi
already, as we have already discussed. We have not presented specific targets for coming years. We have expressed the general philosophy, of course, that we have to move that down to noninflationary levels. I think you judge progress in that respect with what is
going on with inflation in the economy.
The administration has projected, for the next few years, reductions in the inflation rate, which, of course, are consistent with our
intentions. And the lower that inflation rate is, the more room you
have in the terms you are using for real growth. But we have not
made any precise targets for years beyond the current year as yet,
which were to be assessed in the light of what seemed necessary
and desirable at that time against the general philosophy that, yes;
we are looking for continued reductions in the inflation rate and
for the monetary policy that would be congruent with that.
Mr. FAUNTROY. But you do see a velocity of between 5 and 7 percent over the next couple of years?
Chairman VOLCKER. I would not make a judgment on just what
velocity is going to be over that period. You know, in the end,
whether that kind of velocity figure is a reasonable expectation or
not depends upon technology. If we have a lot of reduced use of

what we have in Mi because of the kinds of things you see on the
horizon now; for example, where every time you have a slight surplus balance in your checking account the money is shifted out
automatically—then you need much less monetary growth than
under other circumstances.
If, conversely, we make a lot of progress on inflation, interest
rates are down—as we would hope would be the case—and people
want to hold more money, that represents a kind of equilibrium situation; we are making progress on inflation, we are making satisfactory progress, we want to allow enough room for growth. We
take that into account in our targets.
You are getting out in a time horizon where I think a lot of particular judgments would have to be made at the time, but we are
certainly making those against the background of a monetary
policy which is aimed at facilitating that steady decrease in the
rate of inflation that is projected.
Mr. FAUNTROY. If you were an investor, would you be prepared to
be making investments on the basis of the economic growth projections that the administration has suggested?
Chairman VOLCKER. The market has to make its own judgments,
but these interest rates are extraordinarily high, as has been emphasized, certainly against our objectives with respect to inflation
and what seem to me perfectly reasonable projections of inflation.
From that standpoint, these interest rates look very high and
one might say attractive. But that is me talking. The market has to
make that judgment, and the kind of judgment it makes is going to
have a lot to do with the degree of confidence that it feels that the
inflation rate will come down. The greater the confidence, the
better the prospects for interest rates coming down.
That is not the only factor impinging on interest rates—we have
got this deficit problem, for instance—but it is a factor, and it is a
factor bearing upon the importance of our sticking with the policy,
seeing it through. It is a factor that bears on the importance of the
administration and the Congress carrying through on the fiscal
front. The more confidence there is in that prospect, the better the
outlook for interest rates.
Mr. FAUNTROY. Finally, Mr. Volcker, I am disappointed that you
are not more alarmed than you appear to be about the size of this
deficit and the implications for it if we do not do some serious belt
tightening on those areas of the budget, other than the 3 percent
which I referenced at the outset of the hearing today.
Chairman VOLCKER. I had not expressed my deepest concern
about the course that the budget is on, on the assumption of no
action. I am making a no-action assumption now. Those deficits
seem to me directly inimical to the kind of progress we want to see
both in the economy and with respect to interest rates. And, of
course, those two factors are very much intertwined.
I think the challenge is enormous. It is urgent for the Congress.
The President has presented his budget. He has proposed some
very substantial cuts. He has proposed some revenue-raising measures. As I indicated, I would like to see more progress than that,
but you have a major challenge to achieve what he has indicated is
necessary I would be delighted for you to go beyond that. I think
that would be much safer and more desirable.

What deficit is really appropriate during this period depends
upon the savings rate, how optimistic one can be about that, and
on a number of other factors. But there should be no doubt that
leaving the situation as it stands, without any action, runs directly
counter to the desires that I am sure you have and we all have for
dealing with inflation, with promoting economic recovery and sustaining that recovery.
Mr. FAUNTROY. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Bethune.
Mr. BETHUNE. Thank you, Mr. Chairman.
Mr. Volcker, on page 17 of your prepared statement you say with
respect to the deficit:
Without action to cut spending or, if that fails, to raise revenues, we would face
the prospects of deficits rising in unprecedented amounts.

Chairman VOLCKER. Which is basically the point I wished to
make just now.
Mr. BETHUNE. Then I have a two-part question. One, can I take it
from this language that it would be the preference economically, in
your judgment, to cut spending rather than to raise revenues?
Chairman VOLCKER. In broad economic terms, I think that is correct, in looking at the performance of the economy generally. If
that cannot be done, if there are social, defense, or other reasons
that make that impossible, then I think you have got to go to the
revenue side.
Mr. BETHUNE. Thank you. And the second part of my question
concerns the reference to deficits rising to unprecedented amounts.
Would that be the case if we do not make the policy changes that
the President has recommended?
Chairman VOLCKER. Precisely; yes.
Mr. BETHUNE. If, in fact, we make the policy changes that the
President has recommended and come in with a deficit of $91 billion, then that deficit, as a matter of fact, would be less, would it
not, by any measure than the deficit that we had in the year 1976?
Chairman VOLCKER. Not by any measure. But it would
Mr. BETHUNE. By most measures?
Chairman VOLCKER. Be less by relative to GNP.
Mr. BETHUNE. All right.
Chairman VOLCKER. But then I think that was a very large deficit that year.
Mr. BETHUNE. Yes; it was.
Chairman VOLCKER. And you have got to look beyond 1983, I
think, to the implications of your action. The year 1983, hopefully,
will be a year of recovery, but you want to expand beyond 1983. I
think you must get this budget on a course where 1983 is a transition year to still lower deficits.
Mr. BETHUNE. I agree with you, and I am not making a case for
large deficits.
Chairman VOLCKER. No; I understand.
Mr. BETHUNE. I am just trying to add a measure of perspective to
the discussion.
Chairman VOLCKER. That is right. I was talking about the deficit
before action; the President has proposed a very sizable package of
actions which take effect in 1983 and 1984. You will have to make

the judgment about whether that is the right package, but I would
say go at least that far and, if you can go further, it can be nothing
but helpful. I would feel much more comfortable if the deficit were
reduced more than that.
Mr. BETHUNE. Now let me ask you another question. Regarding
the question of interest rates and the discussion we have had here
about the nature of the forces of supply and demand and how they
operate on interest rates up to this point has focused principally on
the demand side of the equation. We have talked about the deficit
and how it crowds out and takes credit out of the pool.
Of course, I am a sponsor and one of the prime movers in trying
to fashion a credit budget to keep other demand out of the credit
pool. But I do not want to talk about that now.
I would like to shift over and talk a little bit about something we
have not talked about, and that is the supply of credit that might
be available out there.
Chairman VOLCKER. That is right.
Mr. BETHUNE. There has been no discussion of that this morning.
In your prepared statement there is a reference to the fact that we
might see an increase in the savings rate as a result of the tax incentives.
But might we not also see an increase in the available credit in
the country as people's inflationary expectations subside and they
move their money from antiquities, lead bathtubs, rings, and so
forth, and move it into the credit pool? And how would that play
out in terms of interest rates?
Chairman VOLCKER. I would think it could be profoundly important. You could get effects on the savings rate in a favorable direction. I hope and expect that we will, as the inflation rate comes
down. I do not think you can measure that by movement out of antiquities or something else. Somebody has to buy those, and I do
not think that movement has much effect; if you can sell them,
somebody else is buying them. I do not think that is going to have
that much effect on the overall savings rate as a percentage of
income.
But I accept your general point that, as confidence is restored in
the currency, you have a more favorable climate for savings.
Indeed, these high interest rates, for all their difficulties, also provide an incentive for more savings, in addition to the tax measures.
I think there is a good possibility for a higher savings rate. But I
would not want to bet a whole economic program on an enormous,
extraordinary increase in the savings rate. If it happens, that is
fine. But in historical perspective, these things change less dramatically, more slowly, usually. I hope it will go, and I expect it to
go in a favorable direction. But it is a matter of proportion, and to
the degree the rate goes up, it helps.
Mr. BETHUNE. I would like to compliment you on the excellent
statement you made at the outset as to the cause of the recession
that we are in now, when you traced back to some of the fundamental problems that have plagued our economy for a long, long
time.
And I would just follow that with one last question. And that is,
When do you think this recession started?
Chairman VOLCKER. Started?

Mr. BETHUNE. Yes.
Chairman VOLCKER. In the narrow sense, I think the official arbiter said in July. You can always debate with the official arbiter,
the National Bureau of Economic Research. There is always doubt
about the precise month. I think it became clear in the September
figures, let us say. We actually had growth in the overall economy,
according to the gross national product figures in the third quarter.
But July is as good a date as any.
Mr. BETHUNE. That is a couple of months or 1 month before the
Economic Recovery Act was signed.
Chairman VOLCKER. That is correct.
Mr. BETHUNE. The tax cuts did not even begin until October 1.
Chairman VOLCKER. That is right.
Mr. BETHUNE. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman.
As you know, Mr. Chairman, the President has sort of thrown
down the gauntlet now. He has said that if we do not like his program that we ought to come up with something better and we
ought to put up or shut up, so to speak. I think that is a fair challenge, and certainly we ought to do that.
It does seem to me, though, that it is only fair that we understand our economic history and most particularly our recent economic history.
It seems to me clear, from my perspective, that the reduction in
inflation over the last couple of years can be attributed primarily
to Federal Reserve action; and, in addition to this—depending on
how that rate of inflation is measured—the stabilizing of oil prices.
As you indicated, imports have been somewhat cheaper because of
a strong dollar. Finally we have had several good crop years, which
have held down food prices. I do not think it would be fair in any
sense to give the President or his program any credit whatsoever
for this reduction in inflation. They have had no part in it.
Now, what about the recession? The picture there is somewhat
less clear. It does seem to me that interest rates are the prime culprit.
Among a number of factors, I think the very sharp reduction in
the rate of growth in money between April of last year and the fall
of the year must have had something to do with it. Historically,
you can chart sharp reductions in the rate of growth of money with
recessions. There is a very rapid and clear impact.
Then if you ask questions about why they persist, why do we continue to have high interest rates when the rate of inflation is clearly coming down by any measure, the answer seems to be that it is
because we are pursuing policies that are not balanced.
Now we get to the President's program. The investment community is making decisions about the future. There is this ongoing
poll that takes place every day in financial markets, in the stock
market, in the bond market. And what investors are saying there
is that they do not have confidence in this program.
Why do they not have confidence? With all the good intent—and
I certainly do not question the intent of anyone—it is because it is
not balanced. It does not add up. The administration has projected
a deficit of about $100 billion or $90 billion for this year. That is

not a realistic projection of the deficit. It is clear now that the deficit will be much higher than that for this year.
My first question would be on that subject, and I would like to
state two or three questions, if I may, because I know my time will
expire in a hurry.
The first one would be: Do you generally agree with this analysis
of why inflation has come down? And do you generally agree that
the financial markets are making a decision based on their projection of the future? And do you think that this budget estimate is a
correct or a faulty one? And let me just throw in a couple of other
quick ones, if I may.
In the first less than 3 months of this year, Mr. Chairman, already Mi somehow has grown about 43 percent of what would be
allowed to hit the high mark of the Mi target for the whole year. If
you were to hit the midpoint—that is, 4 percent—for the year, Mi
growth has been about 60 percent in less than the first 3 months of
the year than would be allowed in the whole year.
I think that presents a severe problem for you, and I would like
to know how you are going to deal with it.
And I would like, if I may, to ask just one other quick question,
and that is to follow up on this question about velocity. If the President is correct that the nominal GNP is going to be 10.4 percent
and you are going to hit the midrange of your target growth of 4
percent, that would mean that velocity will have to be 6.4 percent,
about double what it has ever been in our history over any same
period of time. I just wonder if you think that is realistic.
And that is the least of my questions. I wish you would touch on
the others first.
And I thank you, Mr. Chairman.
Chairman VOLCKER. I think maybe I will leave the first question,
which had some loaded connotations to it, alone.
Mr. NEAL. How could you say that? [Laughter.]
Chairman VOLCKER. Of course, the financial markets are in the
business of judging the future constantly, and their confidence and
concern about the direction of policy, the mix of policy, underlying
economic circumstances and all the rest, enter into those judgments.
They have been in a highly uncertain state, which just emphasizes to me the importance of consistency in policy, in terms of
monetary policy and other instruments of policy, particularly the
importance of fiscal policy coming into conjunction with what is
reasonably financeable in the periods ahead.
I am less worried about the current deficit, so heavily affected by
the recession, which could pass above the $100 billion level instead
of just below it, as the administration projected. That is a small difference that may be affected by the imprecision of economic forecast. I do not think that is the heart of the problem. The heart of
the problem is out there in the future when the economy recovers.
You refer to the recent increase in the money supply. I do not
know whether it is a problem or not. You can make those kinds of
arithmetic computations that you make. They would look quite different if we had a decline in money supply, which would not upset
us at all, in February or March; then all that arithmetic looks
quite different.

You refer to the velocity computations. I think velocity figures
are much steadier on an annual basis than they are in any particular quarter. We have had a rather exceptional decline in velocity,
apparently, for two quarters in a row, including the present quarter. If you look at the administration projection or most other projections of economic activity for the year and make a reasonable
projection of the average level of the money supply this year entirely consistent with our targets—taking account of what we know
so far—you will find a velocity that is not extraordinary for this
year.
Mr. NEAL. But then the economy could not grow at that rate,
could it?
Chairman VOLCKER. No; if you look at it on a fourth-quarter to
fourth-quarter basis, we had a decline in velocity in the fourth
quarter of last year. We are having a decline in velocity right now
of large proportions. If the economy grew in line with a recovery
forecast for the rest of the year, you would have to get a big increase in velocity for a couple of quarters, but that is not unprecedented coming against the background of very slow velocity for a
couple of quarters.
Looking at this year, there is no necessary inconsistency there.
The CHAIRMAN. Mr. Parris.
Mr. PARRIS. Thank you, Mr. Chairman.
I cannot resist the temptation to add that the previous questioner said that he wanted to put you in that position with some reluctance. That is about like a chicken jumping on a June bug. I think
he enjoyed it.
And this may come as somewhat of a surprise from somebody sitting on this side of the table, Mr. Chairman, but I am going to continue to pursue that line of questioning.
I think communication is the soul of a free society. And as long
as you and I are privileged to represent the public interest, we
ought to try to communicate with the people that we represent.
And I know, talking to you, Mr. Chairman, is always an enlightening experience. It is a lot like sitting through an economics course
in college that I did once long ago.
I know that you must deal in the dispassionate rhetoric of the
financial community, but the report, this report and your statement this morning, was excellent, but it deals in what I call abstract. It is not a red-herring on a security issue.
In one classic understatement that I have underlined here, it
says, "Volatility of the markets may have inhibited aggressive
buying of longer term securities/' That is code for the fact that the
long-term bond market is dead in the water. Nobody will buy anything that deep discount bonds will not be purchased by the rationale American because they have no confidence in the reduction of
inflation in the future.
I listened with some interest to your comments about prices and
the levels of bank deposits being stable. Now, a stable is a place
where you keep a horse. And the only deposits they make is the
inevitable byproduct of anatomical existence. And I think we have
dealt with some of that here this morning. [Laughter]
Mr. PARRIS. I submit to you that the average American believes
that GNP is a pill that teenagers experiment with, or maybe the

initials of a former President, and that MiB is a gun that we used
in World War II, and velocity is something that you and I studied
in high school physics.
What do you do when a homebuilder sits in your office and says
he is in bankruptcy and there is no housing market, which is the
biggest industry in my district, when three-fourths of the people in
construction are out of work, when you cannot sell a house without
engaging in some kind of bizarre financing, when the banks will
not even talk to a small businessman about an extension of credit?
What do you say in the real world? And I submit to you, Mr.
Chairman, that the suggestion that it will get better over time or
that their individual needs are relative to the demands is insensitive, politically naive, and perhaps asinine.
Now, the question, Mr. Chairman, is how much pain can the
American industry, the American economy, and the American citizen stand? Is there no need to let up on the documented human
needs in the real world?
Chairman VOLCKER. You live in what State?
Mr. PARRIS. Northern Virginia. You can hit it with a rock from
here.
Chairman VOLCKER. Pardon me?
Mr. PARRIS. You can hit my area of concern right across the
river with a rock from this building. And it is not a deep industrial
area, Mr. Chairman.
Chairman VOLCKER. No.
Mr. PARRIS. It is a suburban community not untypical, I think, of
most of the United States. I am sorry, I did not mean to interrupt
you.
Chairman VOLCKER. I was simply going to say that the kind of
contact you have with the real world is very similar to the kind of
contact I have with the real world. I am asked the same question,
and I wish I knew a quick and easy answer. I do not, and I feel
very frustrated in responding to that question because I do not
have a quick and easy answer.
I do have the same answer I have given before, and I know how
abstract it sounds sometimes, but it is not abstract at all. The
homebuilding industry, more than any industry, has a stake in the
functioning of the capital markets of this country. And that is
what we are talking about in a very direct sense when we talk
about the competition that the Government provides in that capital
market. It is going to impinge upon somebody else, and the somebody else that it impinges upon first and most heavily is the homebuilder. I think there is considerable understanding of that in the
homebuilding industry.
Mr. PARRIS. Well, Mr. Chairman, just to go back to what Dr.
Paul dealt with just a moment ago, you say in your statement that
a bulge in the money demand early in the second quarter was
steadily resisted by restraining the supply of reserves.
And in your statement you said a very sharp increase in the
money supply developed in January, and a statement that you did
not include in your summary at least was, "as the Federal Reserve
open market operations constrained the supply of reserves/'
Chairman VOLCKER. Correct.

Mr. PARRIS. And I think this is consistent with my previous comments, Mr. Chairman. Is there not some place, does there not come
a time when the Federal Reserve Board in its academic review of
all these multiple charts and graphs and stuff like spaghetti
thrown against that wall, does there not come a time when that
has to be related to what is happening out there in the real world?
And can there not be some middle course where you let up just a
little bit once in a while?
Chairman VOLCKER. Those are judgments that we make all the
time. I think, as my statement and previous discussion have emphasized, we have to stick with and intend to stick with the basic
course of the policy. How one responds to the short-term changes
has elements of judgment in it.
Basically, we are going to resist bulges in the money supply in
either direction. That is what we have done in this recent-period.
Sometimes, you have a certain amount of discretion about how
strongly you resist. I comment in the statement that the January
increase was not deeply disturbing to us because we think it does
have temporary elements and will ease down on its own.
We continue to evaluate the situation, and if we see something
more structural or permanent going on, we would reevaluate the
targets; that is always the case.
Mr. PARRIS. Thank you, Mr. Chairman. My time is expired.
The CHAIRMAN. Mr. Patterson.
Mr. PATTERSON. Thank you, Mr. Chairman.
Chairman Volcker, you are undoubtedly one of the five most
powerful men in the world. I think the fact that the full Banking
Committee has sat here for 2 hours, that this has been a packed
room, that we have people standing outside, and that there are
nine television cameras over there, not to mention how many
radios hanging on every single word you utter, shows that you are
one of the five most powerful men in the world.
As Chairman of the Federal Reserve, you have half the responsibility for our Nation's economic policy and, at least in terms of
monetary policy; the Congress and the President have responsibility for fiscal policy.
What the American people really want to know is when is the
recovery going to occur? When are high interest rates going to
come down? When is unemployment going to come down? And
when are we going to see inflation stay down?
You said, as I recall, earlier in your statement that recovery
would come by midyear. Do you mean this year?
Chairman VOLCKER. Yes.
Mr. PATTERSON. By mid-1982. Now, in your role as Chairman of
the Fed, it seems to me you have kind of two hats you wear. One is
the hat that takes all the tools that the Federal Reserve has and
all the knowledge and all the data, puts it in into some form that
the American people and the banking community can understand
so that we can judge accordingly how to manage our business and
so forth. The other hat is part of a public confidence role where
you say everything is going to get better and be OK.
I guess my question is, when you say recovery will come by midyear, which of those two hats are you wearing? Are you telling us
this in your public confidence role so that we will believe it and

then maybe try to actualize it? Or do you really have the hard data
that supports that kind of forecast?
Chairman VOLCKER. I have not stated outlooks that I do not believe, or given rosey statements for the sake of giving rosey statements. I think what I said this morning was that our analysis suggests a probability that recovery will come before the middle of the
year; it could be several months before the middle of the year.
I also stated that I think there are some risks, as there always
are in any economic forecast. I think that is a correct way to look
at this situation; what kind of actions should we take, should you
take, should everyone take, to minimize the risks and maximize
the potential.
As you quite correctly point out, we are responsible for the monetary side, and we have described our intentions. We have indicated that, for instance, all things considered at the moment, and
given that we had this bulge at the beginning of the year, an outcome in the upper part of the range would be acceptable as influenced by these kinds of considerations.
But I would just come back to the point that, as we view the situation, a major element in assuring the recovery—and I think it is
much more important than any precise date—is that we get policies in place that assure the recovery will be sustained, whether it
begins in March or June, and that it will not soon be forgotten.
The real objective is to continue in 1983 and 1984 and 1985 to get
out of this syndrome of ups and downs and unsatisfactory growth
and productivity and to sustain that policy over a period of time.
There needs to be a contribution from the fiscal side. We have
exactly the opposite situation from what traditional thinking may
have been 20 years ago, that the bigger the budget stimulus the
more growth.
We are getting those deficits out of the way, moderating them,
getting them on a pattern of reduction consistent with recovery;
that is a key to the recovery itself.
Mr. PATTERSON. Do you really think that the Reagan administration's budget deficit of close to $100 billion is going to encourage
recovery?
Chairman VOLCKER. I am not sure that is the real question. The
question is, as the deficit
Mr. PATTERSON. Both this year and the out-years down the line.
Chairman VOLCKER. The President has given you his plans. He
has also told you that without the kind of action that he is proposing—and the Congressional Budget Office has told you that without any kind of action—you are facing a deficit on the order of
$150 billion, rising in subsequent years.
Whatever debate we can have about precisely what level of deficit is appropriate, we ought to agree that that kind of outlook,
without any action, is not conducive to any kind of recovery that
could be sustained; it is not conducive to calm financial markets; it
is not conducive to lower interest rates. That is the point I want
emphasized.
The next question is, "Well, is the President's program big
enough?" That could be a matter for debate. I will tell you, if we
can put together a bigger program and get it enacted, I think that
would be a safer course for the economy.

I have stated on a number of occasions in recent months that I
saw the deficit problem as one that required roughly $100 billion
worth of action by 1984. The President has proposed not quite $100
billion; he has proposed around $82 billion.
I am very aware that $82 billion or $100 billion requires a lot of
action that has not been taken yet, and that is the point I want
emphasized.
Mr. PATTERSON. My time is expired. I do not understand how you
can say that the policies of a President, which in 4 years will be
responsible for the addition of one-third of the entire Federal deficits accumulated in our country's history, how you can say that
such policies will lead us on the road to recovery.
Chairman VOLCKER. You can pull that deficit down faster.
Mr. PATTERSON. No, not whether we can pull it down. I am talking about the President's proposal. In 4 years he is going to have
the four highest budget deficits in the history of the United States
of America. And that is his budget. And you are saying, OK, Congress, go further.
Chairman VOLCKER. I would urge you to go just as far as you
can.
Mr. PATTERSON. Where do you want us to go? To defense?
Chairman VOLCKER. That is a judgment, I think
Mr. PATTERSON. You have one of these long terms. You are appointed by the President.
Chairman VOLCKER. That is not a decision I was appointed to
make.
Mr. PATTERSON. I will trade you jobs.
Chairman VOLCKER. I might take you up on it. [Laughter]
The CHAIRMAN. Mr. Weber.
Mr. WEBER. Mr. Chairman, along those same lines, we are talking about the deficit and the possibility of crowding out borrowers
and putting upward pressure on interest rates, what is the percentage of lendable funds that is now being borrowed by the Government? I hear different figures.
Chairman VOLCKER. I can answer you in a somewhat different
way; I can tell you the percentage of the net savings of the economy that is being absorbed by the Government, which in 1981 will
be about 61 percent.
Mr. WEBER. About 61 percent?
Chairman VOLCKER. Of the net private savings.
Mr. WEBER. What does net private savings mean?
Chairman VOLCKER. It is the total savings of the economy less
the private consumption allowances. If you assume that we want to
invest privately the amount of capital that we are depreciating, we
need about $155 to $160 billion worth of savings. This is last year's
number. The Government in its deficit and in the off-budget programs absorbed about $95 billion of that, 61 percent.
Mr. WEBER. Is that up from previous years?
Chairman VOLCKER. It is up from 1980, slightly. I have figures
for the last decade in front of me; the savings absorbed by the Government ran an average of something below 20 percent in the early
1970's; in the later 1970's it ran about 45 percent or higher. Performance deteriorated all during that period, and the figure is 57
percent in 1980 and 60 percent in 1981.

I think that tells you something about the underlying deteriorating trend in the budget before now.
Mr. WEBER. What is the projection for 1982?
Chairman VOLCKER. This year, of course, we are going to have a
big deficit, and that figure is going to be large. I would guess that it
is going to be larger than last year. But these figures tend to be
large in a recession year because other investment activity goes
down.
The real question is what that is going to be in 1983 and 1984. If
nothing were done to this budget, those figures would remain in
that area or perhaps go higher unless we had an enormous increase in the savings rate. As I said, I think we can expect some
increase in the savings rate, but I do not think we can bet on an
enormous increase in the savings rate.
Mr. WEBER. I have one other question. We had introduced House
Joint Resolution 365, which has been sponsored by the chairman of
our committee and Mr. Reuss and various others. One of the proposals in House Journal Resolution 365 was to leave the Mi target
1982 at the 1981 level.
As I understand it, your 1982 target for Mi is 2.5 to 5.5 percent,
whereas the target for 1981 was something in the range of 3.5 to 6
percent if you are looking at the MiB adjusted, or 6.5 to 8 percent if
you are looking at just MiB.
What would be the implications of leaving the target at the
higher level, which would be the 1981 range, rather than the target
you have adopted for 1982 forMi?
Chairman VOLCKER. Of course, the higher and lower targets
would overlap over a good part of their range, so that would not
necessarily imply coming out any differently. But I think the implication would be that you would be a shade more relaxed on providing money. Whether that is a good idea or a bad idea depends first
of all on what you think the appropriate substantive policy is for
continuing to work down the supply of money.
Conceivably, there could be more structural changes that you
would want to adjust to, which would not have economic significance; you could be adjusting to a change in the marketplace that
affected the amount of money that people wanted to hold in the
particular form that we arbitrarily define as Mi. I noted that if we
were convinced that such structural changes were going on that
gave rise to a larger need for money, then we would look again at
the target, but we are not convinced of that at this time.
Mr. BETHUNE. Would the gentleman yield for a point of clarification?
Mr. WEBER. Yes.
Mr. BETHUNE. When the Chairman states that the Government
is taking a certain percentage of the savings in the country, is the
Chairman including along with the raw deficit the other Government credit assistance programs, the Government-sponsored entities?
Chairman VOLCKER. No. I was including the $20 billion or so of
direct Treasury financing for credit programs off-budget; I was not
including all the sponsored agencies.
Mr. BETHUNE. But there are many more of those?

Chairman VOLCKER. There are many of those. I do not want to be
misunderstood. I was quoting this against the net savings.
If you calculate it against gross savings, the capital consumption
allowances are very big. You get a figure more like the percentage
of total credit in the economy, and then you find in the early 1970's
the Federal share of savings was running at comfortably less than
10 percent. In the second half of the 1970's it was running around
20 percent, and it has been around 20 percent for the last 2 years
and would remain very high this year.
Again, the issue is how big is that figure when you look out
ahead. Again, unless there were a big change in the savings rate, if
something were not done about the deficit, that would get to be a
very high figure historically.
Mr. WEBER. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. D'Amours.
Mr. D'AMOURS. Thank you very much, Mr. Chairman.
Chairman Volcker, thank you very much for coming before us
today. I always enjoy your testimony.
You have been described today in very heady terms, "one of the
five most powerful people in the whole world," the chairman of an
independent agency. I am not sure I agree, by the way, that you
are one of the five most important people in the world. I do not
know who the other four are. You probably consider that a slight, I
do not know.
Chairman VOLCKER. I did not aline myself with that statement.
Mr. D'AMOURS. I am aware that you did not.
But it does tend, your independence and your undoubted importance, does tend to underline, I think, the need, as Howard Baker
said 3 or so weeks ago, for you to have some kind of a summit
meeting with probably the most important person in the world
today, and that is the President.
Have you ever had such a personal meeting with him to discuss
the trade-offs involved in his policy and the things you might be
able or willing to do if he were to implement any given policy?
Chairman VOLCKER. I meet with him from time to time. I certainly do not think of it in the nature of a summit meeting, but
rather as a continuing form of communication and dialog.
Mr. D'AMOURS. Do you one on one with him discuss the trade-offs
on the various policies he is implementing?
Chairman VOLCKER. One on one, we have not.
Mr. D'AMOURS. You have not met with him personally?
Chairman VOLCKER. I meet with him personally, but not with
only two people in the room.
Mr. D'AMOURS. You do not discuss it just between you and he?
Chairman VOLCKER. No.
Mr. D'AMOURS. Earlier, when Mr. Mitchell from Maryland pointed out that your policies are on a direct collision course with the
President's policy, you nodded your assent to that statement when
he made it, that he was stepping on the gas and you were stepping
on the brakes. And you nodded your assent when Mr. Mitchell
made that statement. I assume you agree that your policies are divergent and going in opposite directions. Do you disagree?
Chairman VOLCKER. I do not remember the exact context of that
statement. What I agree with is that it is very important to have

the deficit reduced. The so-called baseline deficit is not helpful
in
Mr. D'AMOURS. I only have 5 minutes. Do you think your policy
is consonant and consistent with the administration's policy?
Chairman VOLCKER. I think our policy is very consistent with
what the administration in general wants to do. The uncompleted
job is the deficit that is sitting out there.
Mr. D'AMOURS. Which is the administration's deficit. Is that consistent with your policy?
Chairman VOLCKER. The administration is trying to reduce the
deficit, as I understand it.
Mr. D'AMOURS. But it also created the deficit, did it not?
Chairman VOLCKER. I do not think I would put it in those terms,
no. I think what is important is
Mr. D'AMOURS. Somebody did.
Chairman VOLCKER. Obviously. The Congress and the President
enacted a big tax reduction last year; you also cut some spending.
The net result, looking to the out-years, is that there was a lot
more tax reduction than there was spending cutting.
Mr. D'AMOURS. I happen to believe, and I hope you do not disagree too strenuously with the fact, that your policy of tightening
up credit in the money supply is not consistent with some of the
tax cuts that were passed last August and with the overall deficit
that the administration has implemented.
And by the way, I do not disagree with the position you have
taken. I think that we have got to get at the underlying inflation
rate.
But I think there is a judgment involved here that it is better
over the near term to have a recession, perhaps even a deep recession, than it is to have pernicious, long-term continuing inflation.
That seems to be how the judgment was made. If that judgment
were not made, you would be relaxing your policy, and interest
rates would be coming down and inflation would be on the increase.
But how long do you think it is reasonable to persist in that judgment and in that policy? What happens if there is no recovery in
July? What happens if there is no recovery by next December? Do
you still persist in your policy at that point?
Chairman VOLCKER. Nobody deliberately sets put, and certainly
we did not deliberately set out, to create a recession. I do not think
we did.
Mr. D'AMOURS. I did not mean to imply in any way that you did.
Chairman VOLCKER. All right, let us leave that aside.
You are certainly correct in your general judgment that our
policy echoes the administration policy, and I think there is a general consensus in the country that we have to deal with this longer
term problem. There are always risks when you try to change the
great momentum of inflation—the great momentum that had adverse effects in other ways, and we are seeing some of those risks
and some of those transitional costs incurred in the interest of putting the economy on a sustained growth path, which is always the
objective.
If you tell me of a situation where the economy continues to decline or not grow for an indefinite period, and if in that situation

the inflation rate was declining and the judgment was this was a
continuing proposition, we would be forced to come back and,
among other things, question whether the monetary growth targets
were right or whether they were not too restrictive in that situation. I do not think that is the kind of situation we are going to
face.
I think you would also look around to see what other policies
need adjustment in those circumstances. Nobody is going to be content and not look at the dial if the economy over a long period of
time were not showing performance.
Mr. D'AMOURS. If the economy does not improve, let us say, by
late summer or early fall or into next winter, would you agree that
that would be a time to reassess your policy, to loosen up?
Chairman VOLCKER. You certainly reassess, but you reassess that
and other policies to see what the source of the difficulty is. I
cannot answer that question now. I would not expect that we are
going to find inadequacy of money in a general way. After all, we
are projecting increases in the money supply. We are aiming for
increases in the money supply.
Mr. D'AMOURS. One thing I would like to clarify as to your policy
of tight money. You indicated in your statement on page 5 that one
of the reasons for the rise in the costs of homes or one of the reasons for the drastic decline in the home market is the inflation in
the cost of the home.
I want to tell you something, every homebuilder in my district
that I have spoken to and every automobile dealer says they can
sell their product at current prices if they could arrange the reasonable financing.
Chairman VOLCKER. I think if the financing were cheap enough,
that is right, but this is an interesting kind of problem. The rising
prices of homes undoubtedly stimulated home purchases for a
while. Everybody said, "Let us buy a house or buy a second house
or buy a bigger house because it is going to have a higher price
next year." As part of the fundamental change in the inflationary
trend, that prospect is no longer so clear, and it should not be so
clear in a noninflationary world.
People are changing their minds about whether buying a house
is a great deal as a speculative investment or as a home; so the industry feels that adjustment very sharply.
You described some scenarios that I do not think are going to
happen, and I certainly do not think they would be caused by a
basic lack of money. We are increasing money. But I am very hopeful that we are in the midst of a fundamental change in the inflation environment and the inflation tendency that has gripped this
country for 15 years and gotten progressively worse over that
period. As it was prolonged, it got more difficult to deal with and
tended to feed upon itself.
There is a lot of evidence that we are beginning to make a fundamental change in that trend, and if we are successful in doing that,
then I think we will have laid the foundation for the converse in
the 1980's of what we saw in the 1970's; that is, that productivity
growth can be sustained over this decade at good rates instead of
dwindling away as it did in the 1970's.

Mr. D'AMOURS. My time has expired. I wish you good luck, Mr.
Chairman.
Chairman VOLCKER. Thank you.
The CHAIRMAN. Mr. Wortley.
Mr. WORTLEY. Thank you, Mr. Chairman.
Chairman Volcker, the Budget Office in a recent report said
there is a significant risk of an unprecedented clash between monetary and fiscal policy that could produce either a flat no-growth
economy or a go-stop economy, and a spike in the interest rates,
driving the economy into recession once again. Are you going to let
that happen?
Chairman VOLCKER. As I read that report—and I did not have a
chance to read it completely—my sense was they drew that implication, although I would not describe it in just the same way. But
you had better not let that happen and deal with the budgetary
problem.
Mr. WORTLEY. Do you and Secretary Regan meet regularly?
Chairman VOLCKER. Yes.
Mr. WORTLEY. The quality of your cigars notwithstanding, is
there a large difference of opinion between pursuit of his fiscal
policy and your monetary policies?
Chairman VOLCKER. I do not have a sense of any disagreement
about the basic thrust of monetary policy. We have, apparently,
some difference of opinion on the significance of short-term fluctuations. On fiscal policy, my private conversations parallel my
public conversations.
Mr. WORTLEY. He does not smoke cigars, does he?
Chairman VOLCKER. No. He gave me some cigars the other day.
Mr. WORTLEY. We all seem to agree on the need to reduce the
deficit when I look at the soaring defense budget. Does it concern
you that in the outyears, in order to achieve the levels of defense
spending that have been projected, that it is going to throw our
balance of payments considerably out of whack; namely, the
American industrial defense base is not broad enough to meet the
needs of the defense budget and a considerable amount of money is
going to have to be spent overseas? Is this a concern to you?
Chairman VOLCKER. I have not looked into that very carefully,
Mr. Wortley. I confess that sometimes you run into that kind of a
problem in an economy that is very tight and in which industrial
capacity is taxed; if you have a big increase in defense spending,
you may impinge on other activities that could go into exports. I
am not familiar, frankly, with the proportion of the defense spending that could go overseas in terms of the future trend.
Mr. WORTLEY. Is it a balance-of-payments problem?
Chairman VOLCKER. The balance of payments has been in pretty
good shape recently relative to other countries, taking into account
that all industrialized countries—or most of them—have to pay a
much bigger oil bill. In recent years our balance of payments has
been relatively good.
I think the strength in the exchange rate of the dollar recently is
likely to bring some pressure on our current account as recovery
proceeds. But it has been in relatively good shape, so some change
within limits there would not be terribly disturbing.

You can always go too far, and our external competitive position
is something that has to be continually watched, but I am not concerned about the outlook in the next year or two.
Mr. WORTLEY. Thank you, Chairman Volcker.
The CHAIRMAN. Ms. Oakar.
Ms. OAKAR. Thank you, Mr. Chairman.
And I thank you, Chairman Volcker, for coming.
It is interesting to me to see the kind of mutual admiration society that you and the administration have. I noticed Sunday, watching Secretary Regan, that he endorsed your tight-money policy, and
today on page 16 you comment on the positive effects of the tax
bill.
Would you not agree that the tax bill and high unemployment
also add to the deficit? I am from Ohio, and our State has the
second highest unemployment in the country, 12.5 percent. And a
lot of our people think that is directly attributable to the tight
fiscal policies, the high interest rates, and the impact of the budget.
Now, with another budgetary proposal that guts out unemployment programs and so forth, they are very concerned.
My question to you and, in effect, to the President, because I
think you really both basically agree with the approach: How long
can my State wait, how long can these unemployed workers wait?
They do not have money to save. I mean savings are out of the
question for them. They think this is the end of the middle class.
And what is happening to them—and these are not just the
autoworkers and the steelworkers, these are career employees who
are 45 years old, who were making $35,000 or so a year, who are
now out of a job and have no future, no optimistic reports in their
favor.
And so we are seeing in our State—and I am sure this is happening across the country—we are seeing our small farms go under,
we are seeing our small businesses go under, we are seeing traditional jobs eroded. We are seeing an increase in divorce, we are
seeing an increase in mental illness. We are seeing an increase in
crime. We are seeing an increase in suicides.
How long are the American people supposed to wait because
some economists think that when you bring down the inflation rate
by a percentage or two, you have to sacrifice 3 million more jobs.
How long are the people supposed to wait? You told us a number of
times that an upturn would be on the horizon. How long can they
wait?
Chairman VOLCKER. If I knew an easy answer to the question of
dealing with that problem, a solution that I did not think created
worse problems, I would not keep that light under a bushel.
Ms. OAKAR. But you endorsed a tax bill—you kind of contradicted yourself earlier—but you endorsed it on page 16.
Chairman VOLCKER. I indicated some of the potential benefits of
that tax bill on productivity and all the rest. I think I
Ms. OAKAR. But it added to the deficit, did it not?
Chairman VOLCKER. I spent a year before this committee and
other committees indicating my concerns about the imbalance in
the budget that could result. I think we are left with that imbalance in the budget. It seems to me the implication of that tax bill
is that it gave up much more in revenues than it saved on the

spending side. The job is clearly incomplete, because we are left
with this deficit situation. And you are right, the unemployed add
to the deficit.
Ms. DAKAR. By about $25 billion, is it not, for every percentage
point?
Chairman VOLCKER. When I look at that deficit, I mentally discount the part that is due to the rise in the unemployment rate
and the recession.
Ms. DAKAR. Why would you do that when you are mandated by
the Humphrey-Hawkins Act to consider it? How ironic it is that
you would make a statement like that. I mean I have to lay it on
the line, I do not think you are concerned. Here you are mandated
by the Humphrey-Hawkins Act, which has as its major goal full
employment for this country, and you come to this committee and
say you mentally discount unemployment.
Chairman VOLCKER. No; I did not say that.
Ms. DAKAR. I do not see a thrust toward eliminating that problem.
Chairman VOLCKER. Wait a minute; we are not communicating. I
do not mentally discount the unemployment. In assessing the
budget, I mentally take account of the impact on the budget of the
unemployment so that I do not overestimate the underlying deficit.
What concerns me is not the $25 billion that you lose in revenues
or additional spending because the unemployment rate is up. What
concerns me is that the deficit would go up when the unemployment rate declines.
Ms. DAKAR. Wait a minute. Just so I understand what you just
said. You just said that what concerns you is not that there is a $25
billion deficit or an impact on the deficit when there is 1-percent
increase in unemployment?
Chairman VOLCKER. I would rather not have it, but the problem
is the unemployment.
Ms. DAKAR. What really concerns you? Finish that sentence.
Chairman VOLCKER. The problem that concerns me is the unemployment.
Ms. DAKAR. Yes. And that adds to the deficit.
Chairman VOLCKER. That does add to the deficit. But the $100
billion deficit, to me, has an ingredient of reaction to the unemployment. The unemployment is bad, and among its other consequences, it increases the deficit. But I would not be up urging you
for action on the deficit or on the budget if that deficit were going
to disappear as the economy recovered and the unemployment rate
went down.
The problem is the deficit is going to get bigger without any
action even when the economy recovers and the unemployment
rate goes down.
Ms. DAKAR. Let me tell you, people employed are a lot more important than whether or not the deficit goes up or down, when they
are committing suicide. They will not have to worry about any deficit in the way you define it.
Chairman VOLCKER. I agree with that. But how are we going to
help the person employed or the person unemployed? What I am
suggesting to you is that that budgetary outlook is a hazard for
those very people who are unemployed. They have more at stake

than anyone else, in a sense. The unemployed carpenter has more
at stake in reducing that deficit during a period of recovery than
any other person in the economy because he is going to be most
directly affected by the competition of the Treasury in the markets.
I do not have to limit it to a carpenter.
Ms. OAKAR. Well, let me say my time is expired. But I do not
think you or the administration fully developed a policy of diminishing the high unemployment rate that we have in this country,
which you acknowledge adds to the deficit. That does not seem to
be of paramount concern for you or the President, witness his
speech in which he hardly even mentioned it.
Chairman VOLCKER. If we have any difference, and I am not sure
that we do, it is my concern to create conditions that minimize the
chances of being back in this situation again or prolonging this situation. We may have some differences as to how to do that, but
there cannot be, I think, any fundamental difference about the fact
that that is the key problem and challenge, to get together a set of
policies that will get the economy on the right course.
Ms. OAKAR. In the meantime, they will be dying off and so on.
Right? Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Lowery.
Mr. LOWERY. Thank you, Mr. Chairman.
Chairman Volcker, you stated that you thought the recession
probably began about July, a month before the President's program for economic recovery took effect, and certainly before the
tax cuts took effect. Would you say that the recession we are currently in would be more severe without those programs having
been enacted, particularly the tax cut aspect?
Chairman VOLCKER. I am not sure I have any strong feeling on
that one way or the other. You have some support from the tax
reduction that was made in the fall. On the other hand, concerns
about the deficit have been a big factor in the financial markets,
which, of course, affects business activity.
I think that program has to be judged by its long-range implications and how it comes out over time. And I agree it has not been
in place very long; only a small portion of it has been in effect.
Mr. LOWERY. Would you concur with the soundness of the idea of
stimulation to the economy, to increase productivity?
Chairman VOLCKER. The 5-percent tax reduction, by providing
some stimulation in the fall; yes.
Mr. LOWERY. You suggest that you are looking to the second or
third quarter of this year for an improved economy. On what information do you base your suggestion?
Chairman VOLCKER. On analysis of a variety of recent trends. We
have had a sharp decline in production. We have some evidence of
inventory liquidation at the moment. These are the kinds of forces
that usually presage a cyclical recovery. We do have a second stage
of that tax program coming in July which provides some assurance
that disposable incomes will increase at that time.
I think there is quite a lot of repressed demand in the economy,
if I can put it that way. Interest rates are at extraordinarily high
levels. I would hope and expect that they would come down at
some point; I do not know the precise timing, but that would also
provide some support.

You have some normal cyclical developments, the depressing effects of which may be waning and will be taken over by expansive
effects and you have some policy measures that will help.
Mr. LOWERY. Do you feel the July tax cuts will have a very positive influence?
Chairman VOLCKER. I think they provide quite a lot of insurance
that that could happen.
Mr. LOWERY. What do you think about the advisability of accelerating the tax cuts from July to January or April to stimulate the
economy?
Chairman VOLCKER. I have seen a couple of different versions of
that proposal. Do you accelerate it with the same revenue loss,
which means a lower percentage cut, or do you bring the whole
thing forward and make the immediate deficit a little larger? I do
not feel enthusiastic about either idea.
The thing is in place. It is not very far off. It would be hard, I
think, mechanically, to accelerate it very far now in terms of
changing the withholding pattern, which is what presumably
would count.
Mr. LOWERY. Mr. Chairman, it strikes me that the President's
program is sound, but it will take some time to work. The concern
that I have is with the Federal Government and the money markets; specifically, I have heard percentages anywhere from 42 percent to 78 percent of available credit goes to finance Federal deficits. I do not know what figure you would use.
Chairman VOLCKER. I gave some figures earlier, which represent
one particular way of looking at that, matching savings against the
Government deficit. It takes either 60-plus percent, if you take the
net, and it takes half of that or less if you take the gross. You can
look also at it against the total volume of funds in the credit
market.
I think whatever particular measure you take, the problem is the
Government takes a high and rising proportion—if nothing is done
about the deficit.
Mr. LOWERY. Is that the stumbling block, the private sector
having sufficient credit available to finance the recovery?
Chairman VOLCKER. In the kind of conditions we have now,
where we obviously have congested credit markets, that is a problem.
Mr. LOWERY. Have you an estimate as to how many dollars
would be required to finance economic recovery, this pent-up frustration of enterprise to reinvest?
Chairman VOLCKER. I do not have any figures at hand. Sometimes we make estimates, with a given increase in economic activity, of the implications for different kinds of financing. I do not
have any with me now.
Mr. LOWERY. If you could provide me with those figures, I would
be very appreciative.
[The information follows:]

87
Chairman Volcker subsequently submitted the following
information for the record.

Table 1 shows an estimate by Federal Reserve staffof total credit obtained by nonfinancial sectors of the economy
that might, in terms of historical patterns, be consistent with
the Administration's GNP forecast for FY 1982-84.

As may be

seen, absent the enactment of the Administration's deficit reduction program, the Treasury will be absorbing a very large share
of aggregate credit flows (and these figures on federal borrowing
do not include guarantees or sponsored agency takings).
These data employ Administration estimates of the
deficit.

The CBO has estimated significantly higher deficits,

before or after assuming enactment of the President's budget.
Note also the appropriate historical comparisons
for fiscal 1984 should be with earlier prosperous business years,
not with recession years when Federal financing is normally
an exceptionally large share of credit markets.

88
Table 1
FEDERAL BORROWING AND CREDIT MARKETS

Total funds
raised by
non financial
sectors

Federal borrowing from
the public

($ bil)

(%)

1972

152

12.8

1973

198

9.8

1974

187

1.6

1975

174

29.2

1976

242

34.3

1977

310

17.2

1978

379

15.6

1979

413

8.1

1980

342

20.6

19.6

Fiscal
years

1981

405

1982e

420

115 (118)2

494

108

548

1983
1984

Federal borrowing as a
% of funds
raised

27.4 (28. II2

(164)

21.9 (33.2)

97 (181)

17.7 (33.0)

Nonfinancial sectors, excluding equities.

Numbers in parentheses assume the Administration's deficit
reduction program is not enacted.

Source: Special Analysis F, Budget of the United States Government,
1983 except for 1982, 1983, and 1984, which are staff projections
based on Administration's economic and budget projections.

Mr. LOWERY. The Treasury Department offsets the deficits by
saying that we will see sufficient savings growth to cover the $100
billion deficit to meet the private sector needs. What would your
comment be on that?
Chairman VOLCKER. I have two comments. First of all, they use a
$100 billion or $90 billion or $80 billion deficit out in the future.
We are not there; we are $80 billion away from there or more in
1984 as things stand, so when you say that deficit can be financed,
if that statement is right, you are talking about an $80 billion problem just to get you there.
I would also feel that you might still have a problem; I would not
want to count on that big an increase in savings.
Mr. LOWERY. What are you using by way of numbers to project?
Chairman VOLCKER. I do not have a precise number. I do not
know what their precise numbers are. But given the numbers I
have had, it seems to me the implication would be a very sharp increase in the savings rate. As I said, I think we will get some increase in the savings rate, but I would not want to count on an increase as sharp as that projection.
Mr. LOWERY. Mr. Chairman, if you could provide me with the
best available numbers you have, I would be most appreciative.
[The information follows:]

90
Chairman Volcker subsequently submitted the following
information for the record.

Table 2 gives some hypothetical saving projections,
based on patterns observed in earlier years.

While the range of

possible outcomes is substantial, the figures indicate that the
federal deficit will be absorbing a comparatively large share
of total private saving in the economy unless major steps are
taken to cut spending or increase revenues.

It is interesting

to note that the deficit-to-saving ratio looks especially high
in comparison to earlier experience in relatively prosperous
times, which is the appropriate comparison for projections based
on an assumption of a high level of business activity.
Note that these data are Administration deficit program and GNP estimates; other estimates (e.g., by the CBO) suggest
higher deficits and consequently greater strain on our savings
capacity.

91
Table 2
DEFICITS, GNP AND SAVING
Budget
Deficit

Fiscal
Years

-1.6
-3.8
-8.7
-25.2
3.2
-2.8
-23.0
-23.4
-14.8
-4.7
-45.2
-66.4
-44.9
-48.8
-27.7
-59.6
-57.9

*1965
1966
1967
1968
1969
*1970
1971
1972
*1973
*1974
1975
1996
1977
*1978
*1979
1980
1981

Deficit as
Z of

(-6.1)
(-53.2)
(-73.7)
(-53.6)
(-59.1)
(-40.1)
(-73.8)
(-78.9)

0.2
0.5
1.1
3.0
0.4
0.3
2.2
2.1
1.2
0.3
3.1
4.0
2.4
2.3
1.2
2^3
2.0

Deficit as I of
gross non?-

(0.4)
(3.6)
(4.5)
(2.9)
(2.8)
(1.7)
(2.9)
(2.8)

Deficit as Z of
net non-

1.5
3.2
6.7
17.7
2.3
1.9
13.5
11.9
6.6
2.0 (2.6)
18.2 (21.5)
22.8 (25.2)
13.0 (15.6)
12.3 (15.0)
6.6 (9.5)
13.3 (16.5)
11.7 (15.9)

3.0
6.1
12.9
34.5
5.0
4.2
29.3
24.9
13.1
4.2
45.8
53.2
29.1
27.0
15.9
35.2
31.5

(5.5)
(53.9)
(59.0)
(34.7)
(32.6)
123.0)
(43.6)
(42.9)

Potential Deficits with No Saving Plan (Administration's "Baseline")3
1983
1984

-147 Cn.a.)
-167 (n.a.)

1983
1984

-92 (-107)
-83 (-97)

4.3 (n.a.)
4.4 (n.a.)

21.2 (n.a.)
20.7 (n.a.)

n.a.
n.a.

Administration's Proposed Deficits

Deficit
adjusted to
6Z unemployment

2.7 (3.1)
2.2 (2.6)

13.2 (15.4)
10.3 (12.0)

High Employment
High Employment
Deficit~as Z oi
Deficit as Z of
potential GNP gross nonfederal saving^

n.a.
n.a.
High Employment
Deficit as Z of
net nonfederal saving

Potential Deficits with No Savings Plan (Administration's "Baseline)3
1983
1984

90
128

2.5
3.2

13.7
18.0

37.0
48.6

5.3
6.2

14.4
16.7

Proposed Deficits

1983
1984

35
44

1.0
1.1

1. Unified budget deficits; data in parentheses include "off-budget" programs financed
by U.S. government.
2. NIPA gross saving excluding NIPA fEBeral surplus (or deficit) plus net foreign investment (sign reversed); net nonfederal saving equals gross less capital consumption allowance with adjustment.
3. CBO estimates of baseline deficit are somewhat higher.
4. Saving as percent of potential GNP equals ratio in average of high employment years
in the 1970s.
*Reasonably prosperous years; unemployment rates of 4.9Z, 4.0Z, 5.2Z, 5.0Z, 6.3Z, and
5.8Z, respectively.

The CHAIRMAN. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
President Reagan, with the Fed's cooperation, has really been a
wonder. In just 1 year his policies which Congress, the administration and the Fed have followed with a passion have taken an economy on its knees and knocked it on its back.
You have been a good soldier, Mr. Volcker, on the Federal Reserve Board. You have carried out well the Reagan-Regan—Sprinkle supply-side scenario, in spite of the fact that everyone gets a
little paranoid with regard to whose side you are on. In fact, there
is a question in my mind really as to just how independent the Federal Reserve Board is at all today. I really begin to wonder.
The Fed appears to be a cog in the free-market wheeler-dealer
Reagan economics. The Fed has abandoned its role of leadership,
which fits well with the Reagan withdrawal of the National Government from the real economic world.
Indeed, one could easily deduce from your statements that the
Federal Reserve Board has nothing to do with nor responsibility for
the economic consequences of these policies. Let me remind you
that the recession deficits to which you seem to give your tacit
blessing this morning are not being targeted to the distressed. I
want to make that very clear. These deficits you say we ought to
tolerate are not going to the people that are unemployed in this
country to fill the role of the economic shock absorbers as they
have in the past.
In fact, they are going to the special interest hemorrhage of tax
dollars that was passed and an explosive Pentagon spending program, which I noticed again that you find necessary to refer to in a
positive sense in your statement.
Lord save us if this is conservative economics. Your endorsement
of Reaganomics today amazes me, especially when you keep your
foot on the brake while the Republican administration pours on
the gas. Figuratively, these policies are tearing this country and
our economy apart with really the worst economic circumstances
since the Great Depression.
There are a number of questions that I would like to ask. But the
first one is, are you willing to let monetary policy function on the
same basis that we passed this tax bill, all of these activities passed
into the future without any idea of what the hell is going on out
there in the future? In other words, we have got tax cuts going into
effect, we have got indexing, we have got these lease provisions. Do
you think that monetary policy ought to be run on the same basis,
on this free-market system so that everyone knows what to expect
in the future?
Chairman VOLCKER. Let me say, first of all, that we are only responsible for monetary policy, and I think you implied—or I inferred from your statement—that you were giving me responsibility for elements of the administration's program that I have absolutely nothing to do with.
Mr. VENTO. Are you under any restraint? I am not familiar with
any restraint with regards to your voicing your opinions on the
fiscal side of the equation for deficits. I notice that the only word
that you could give us this morning on the deficit was pretty much
the same thing that the President has said. That is, if you want to

do something to improve it, why don't you do it? That is fine, but
anything you can do will be helpful.
Chairman VOLCKER. That is right. I am very concerned about
that deficit, but I do not think it is my function to tell the Congress
or the administration what the defense program should be or what
the mix of expenditures should be.
Mr. VENTO. Well, you do not have to tell us, but you can suggest
that this deficit is unacceptable, that a deficit of something less,
that a tax bill that automates—how about the question on the
automated nature of monetary policy right along the same economic lines as the tax policy that was passed?
Chairman VOLCKER. Let me comment on monetary policy. I have
tried to make my view perfectly clear, that the smaller that deficit
is the happier I am. It is much too big as it stands, and if you can
go beyond the President's program, I wish you well. I urge you to
go beyond the President's program.
Mr. VENTO. Well, I was going to ask you a question about that
program.
Chairman VOLCKER. You made some references to independence.
I am not aware that the basic thrust of our monetary policy is any
different now than it was since I took office.
Mr. VENTO. I agree with that, and I agree that it took effect in
the October 1979 fiasco that you initiated. I want to ask you a question about that. Has the Federal Reserve given up any significant
part of its responsibility when only dealing with—and I might add,
imperfectly, as I think you have noted in some of your comments—
the monetary aggregates and discount rates and not directly targeting toward interest rates.
Do you not think that you have given up anything? You have got
the greatest resource in terms of information. I heard you spewing
out these facts on capital, which I have some questions on also. But
have you not really given up a great deal? I mean this fits in with
the free-market philosophy that actually arrived 2 years before
Reagan and the manifestation of that outrage.
Chairman VOLCKER. I do not know whether that goes to any philosophy of free markets, but I think we do have a different method
of targeting now, and we have given up something in that process.
That is right; we gave up something in order to get something else.
Mr. VENTO. Well, the something else that you have given up I do
not think is acceptable to small businesses and the recovery that
you talk about. I think you are going to wash out all the small
businesses that are credit dependent. And that carpenter, I will
worry about him. The carpenter is not going to have any money
because the tax bill that was passed is going to take and strip all of
that money out of housing.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Coyne.
Mr. JAMES COYNE. Thank you, Mr. Chairman.
I would like to welcome you back, Mr. Volcker. I guess you are a
little relieved, after listening to this for over 3 hours, that no one
has blamed you for the bad weather in January. They seem to have
done a good job of blaming you for just about everything else.

In fact, I was surprised to hear one of the Members on the other
side suggest that they should be switching jobs or the two of you
could swap.
Of course, what we have been hearing for much of the last 2
hours is people trying to get you to do their job. Congress has a job
to do. It has had a job to do for 40 years that I think it has ignored
and shirked.
Mr. PATTERSON. Will the gentleman yield to me?
Mr. JAMES COYNE. Certainly.
Mr. PATTERSON. I think you referred to my comment. If the gentleman would yield, the reason I was going to switch jobs was more
to get a longer term, but also I think I could recommend better Fed
policies. And perhaps Chairman Volcker, he keeps telling us Congress has to do the balancing of the budget, not the President nor
he in their lockstep agreement.
Mr. JAMES COYNE. I was referring to your colleague from Ohio
when I was making the reference.
Mr. PATTERSON. Oh, I am sorry, I thought you were referring to
me.
Mr. JAMES COYNE. It was your colleague from Ohio that was
Chairman VOLCKER. Just in case there is any doubt, I think the
budgetary policy is a joint project of the administration and the
Congress.
Mr. JAMES COYNE. Well, that is the point I am trying to make. If
I could reclaim my time, Mr. Chairman.
The point I am trying to make is that our Constitution gives to
Congress and gives to the administration the responsibility for
drafting the budget. We have heard over the last couple of weeks
this great debate about this so-called budget. The cold, cruel reality
is that we really do not have a budget. We have almost lost the
ability to create a budget. Many Members of Congress over 40
years have become pleased and comfortable and relaxed with the
capability of getting reelected by promoting more spending and
then financing that spending by getting you to print more dollars.
I think you essentially tossed down the gauntlet 2 years ago
when you said that we were not going to keep printing more dollars, we were not going to keep financing a profligate Congress
that was refusing to balance its own budget. You said you were
going to turn back to Congress its own responsibility to decide how
much of our country's GNP it was going to be spending on Government services.
Of course, this Congress is rebelling. It is being forced like a
small child to do what it is supposed to do, and now they come to
you and ask you to tell them where to spend the money. My colleagues are saying, you tell me how much to spend on defense. I
just find it a dereliction of our duty here in Congress to face some
tough decisions.
Granted we have an election coming up in November. Granted
that it is easier to face an election by telling people, "You will not
be unemployed/' but then do some fancy footwork with deficit
spending and make sure that that person is unemployed this year
and that he will still be unemployed 2 or 3 years from now.
But decades and decades of fancy footwork and printing more
money has got to come to a stop. I am very pleased that you have

had the courage to come before this group and accept the tongue
lashing that a lot of people are so eager to give you but at the same
time are turning that tongue lashing back.
Now my question is, Do you have the resolve, and does the Federal Reserve have the resolve, not to reflate in the face of all this
pressure? On that chart you can see that a few months before the
last congressional election there seemed to be a small period of reflation, where some people allege that the Federal Reserve was not
sticking to its guns, and that in order to buckle under to Presidential power at that time, it was persuaded to reflate and, of course,
lower its effort to control monetary growth.
Are you going to be continuous in this policy throughout the
year and be adamant in not reflating the economy despite what
our colleagues in Congress say and despite what pressure may
come even from the administration itself?
Chairman VOLCKER. Yes, sir, the whole thrust of our policy is not
to have inflationary increases in the money supply. I might recall
that during that period when we had 5 months or so of too rapid
growth in the money supply, we did move to restrain it. One can
argue whether we moved too fast, too slowly, or whatever. All I
know is we got a certain amount of criticism from the administration at the time.
Mr. JAMES COYNE. Well, I hope we can maintain this independence.
The other question I have is a more technical one dealing with
your interest in stimulating savings. It seems to me that there is a
qualitative priority here as well as a quantitative one. We are talking, as you were in your testimony, about the increase in shortterm savings, or what you call highly liquid deposits, which a lot of
people are putting into NOW accounts or money market funds.
How are we going to really build up our housing and our durable
goods sector without shifting the focus to long-term savings? Do
you only feel that you have a responsibility to urge us toward savings in general, or cannot the Fed do something through administrative procedures to create greater incentives differentially for
long-term savings versus short-term savings?
Chairman VOLCKER. I do not think there is much that we can do
about the savings rate in general or the direction of savings—I'm
speaking of the Federal Reserve now, not of fiscal or other measures—except to do what is most fundamental of all, restoring confidence in the currency. The key problem in the financial markets,
in the long-term financial markets, is that that confidence has been
eroded over a long period of time.
Mr. JAMES COYNE. But it seems to me that your answer to my
prior question is exactly the type of thing that is going to restore
confidence in that currency.
Chairman VOLCKER. That is right.
Mr. JAMES COYNE. We have confidence that you and your successors and the other members of the Board are going to continue that
fight. The problem may, in part, take care of itself. People will
have more confidence in the dollar and begin to save long term.
Chairman VOLCKER. That is an underlying rationale of our
policy.

Mr. JAMES COYNE. Well, I hope it is successful, and I hope that
you will continue on this effort.
We, of course, are seeing many elements of our economic marketplace and the financial institutions raising questions about your resolve. I think in the last year and a half, if there is anything that
the marketplace has determined, it is that you are consistent and
sticking to your guns. The uncertainty that causes distrust is not
uncertainty with the Fed, it is uncertainty with Congress. I think
right now there is the highest level of uncertainty as to whether
Congress will stick. I just wish that we as a body had the type of
commitment to our program that you do.
Thank you very much.
Chairman VOLCKER. Thank you.
The CHAIRMAN. Mr. Patman.
Mr. PATMAN. Mr. Volcker, when the budget and tax bills were
passed in 1981, Congress was told that we would have a balanced
budget by 1984. Did you know last year that those representations
were false?
Chairman VOLCKER. You put it in a prejudicial way, obviously. I
did not make any—and you did not say I made any—such misrepresentations.
Mr. PATMAN. Of course.
Chairman VOLCKER. I repeatedly stressed to the Congress my
skepticism on the budgetary outlook.
Mr. PATMAN. When did you know they were really false, at what
point during the year?
Chairman VOLCKER. Well, I do not know when one knows an outlook is really "false." You are looking out over a long period of
time. It was apparent at the time; I think I said out loud, repeatedly, that to have a balanced budget or come close to a balanced
budget, and if you were going to have that tax bill, you were going
to have to cut spending a lot more than you cut it last year.
I repeated that and repeated that and repeated that. I urged, you
may recall, to do the expenditure cutting before the tax bill so that
you made sure that you did it.
Mr. PATMAN. Now, are the representations false that are now
being made by the administration with respect to its budget for the
fiscal year 1983 and its projections for 1984 and 1985?
Chairman VOLCKER. You have more experts predicting the
budget, both in the Congressional Budget Office and in the OMB,
than I have. We look at the budget in a shorter term time perspective.
When you look at the 1983 trends reflected in roughly a $100 billion deficit for 1983, without any action, I do not find that an unreasonable estimate. Our analysis would show the same thing.
When you go beyond that without any action, the deficits will get
bigger.
Beyond that, you are asking both about economic forecasts in the
near term and what the administration and the Congress will do to
cut the deficit. Anyone can have a judgment on those.
Mr. PATMAN. Will you support the representations that are made
this year by the administration on its budget projections for next
year, for fiscal year 1983?

Chairman VOLCKER. I think one can quibble with the details. In
general magnitude, what those projections show, as I understand it,
is a large and widening deficit as the economy recovers, and I
agree in general contour that is the prospect we face.
Mr. PATMAN. In other words, your statement last year, except for
some reservations and some concerns expressed about the tax bill?
Chairman VOLCKER. I had a similar concern last year.
Mr. PATMAN. You do not have the same concerns this year then?
Chairman VOLCKER. I had a similar concern last year that the
deficit was going to get larger and not smaller, and I expressed it.
Mr. PATMAN. Last year did you warn the administration that its
fiscal policies would result in higher interest rates?
Chairman VOLCKER. I urged the administration to lower the deficit, yes, and I expressed my concern about high interest rates. I expressed it publicly.
Mr. PATMAN. Did you tell the administration that it would have
higher interest rates in this country caused by its policies?
Chairman VOLCKER. I expressed that publicly, repeatedly, Mr.
Patman.
Mr. PATMAN. You said higher interest rates were coming if the
administration's program was adopted?
Chairman VOLCKER. I may not have put it in those words.
Mr. PATMAN. But that is what you felt?
Chairman VOLCKER. I felt that if you were going to have bigger
deficits, you would have a problem, and that was the course we
were on. In 1981, we were talking about deficits in 1983 and 1984.
Nobody knew what the administration or the Congress was going
to do between 1981 and 1983 and 1984. I recall using quite explicitly in testimony before the Budget Committee last summer that
$100 billion figure; I said that on the course we were on you had to
do $100 billion more to get the deficit, not to zero, but in shape.
Mr. PATMAN. And did you tell the administration that we were
headed toward a recession if we adopted their policies?
Chairman VOLCKER. You put that in a prejudicial way: "Did I
tell the administration we were headed for a recession if we adopted their policy?" I told the administration that I thought there
were great uncertainties in the business outlook and that things
might not move as fast as they hoped, all through last year.
Mr. PATMAN. Did you tell them at any point that the recession
was coming because of their policies?
Chairman VOLCKER. I told them you cannot exclude that possibility; I never have.
Mr. PATMAN. Cannot exclude it?
Chairman VOLCKER. Last year, again, I said it publicly. There
seems to be some implication I tell them something different than
what I say publicly.
Mr. PATMAN. And did you say publicly that we were headed for a
recession?
Chairman VOLCKER. I did not know we were headed for a recession for a certainty. I thought there was some risk.
Mr. PATMAN. Does the administration fully support your actions?
Chairman VOLCKER. The only thing I can conclude from what
they have said is that they support the general thrust of our intent

and policy to bring down the growth of money. They obviously
have some concern about how we go about it.
The CHAIRMAN. Mr. Schumer.
Mr. SCHUMER. Thank you, Mr. Chairman.
Chairman Volcker, just to relieve you of the fact that your ordeal
today is nothing new, I would like to read you an excerpt from one
of our great works of literature that was written about 80 years
ago.
It said, "The crying need of the Nation is not for better morals,
cheaper bread, temperance, liberty, culture, redemption of fallen
sisters and erring brothers, nor the grace, love, and fellowship of
the Trinity, but simply for enough money/'
And that was from Major Barbara. I am sure after today you feel
more like St. Joan than Major Barbara.
I would like to ask you a few questions. As you know, I have a
great deal of respect for your integrity and this difficult tightrope
upon which you must walk.
But let me ask you this. Right now, if nothing else were to
change in terms of your monetary projections, you stick to those,
Congress does everything that the administration now has proposed with one exception, the deferral of the 10-percent personal
income tax in 1983, would that be a better or worse move for our
economy?
Chairman VOLCKER. You give me an awkward choice; there are
obviously other alternatives.
Mr. SCHUMER. Well, this may well be the choice that we will
face.
Chairman VOLCKER. I am not sure, because obviously as nearly
as I can see, they would be dead set against that.
If you ask me whether we would be better off taking further
action that takes effect, say, late in fiscal 1983 and 1984 to reduce
the deficit, yes, I think we would be better off. Whether that particular form of action is desirable and necessary is another question.
If you ask me whether another $30 billion or $40 billion off that
prospective deficit, everything else equal, would be a good thing,
yes, I believe that would be a good thing.
Mr. SCHUMER. You believe it would. No matter where it came
from?
Chairman VOLCKER. That is right.
Mr. SCHUMER. Increased taxes?
Chairman VOLCKER. In general.
Mr. SCHUMER. I will grant you that.
Next question. I am very perplexed that the chairman of our
committee, our distinguished chairman, had asked you earlier
about the 10- to 11-percent T-bill note rate that the administration
had projected. I do not understand that.
I consider the $91 billion deficit in the 1983 budget as something
that I call a new language in America, called Stockmanese. I think
$91 billion in Stockmanese is about $140 billion in English.
And the reason for that is this, and I just would like your comment on it, I do not think you can project the following three
things at the same time economically unless you really stretch
your economics: a 5.2 percent growth in the GNP; a T-bill rate at

10 to 11 percent; and a $91 billion deficit. They just seem to me
inherently contradictory.
Would you care to comment on that?
Chairman VOLCKER. I thought you were going to put the money
supply in that equation, too.
Mr. SCHUMER. That gives you an out.
Chairman VOLCKER. That is right. You say "inherently contradictory/' I do not know what you are referring to. I am searching for
their estimates.
Mr. SCHUMER. Those are their estimates.
Chairman VOLCKER. For what year?
Mr. SCHUMER. 1983.
Chairman VOLCKER. 1983. The stronger the recovery is in 1983
all other things equal, the greater the pressure on interest rates.
Mr. SCHUMER. That is just my point.
Chairman VOLCKER. I realize that is your point. And the higher
the deficit is, the more strain there is going to be. But I do not
think I want to say, without a lot more analysis, anyway, that that
is an impossible combination of circumstances. My instinct would
be that it is not, but there are a lot of risks in the other direction.
Mr. SCHUMER. I mean you would put it if in other words the Tbill—let us keep the other two figures the same, 5.2 percent, $91
billion deficit—you would say it is far more likely that the T-bill
rate would be 12 or 13 or 14 percent than it would be 11 percent or
10.5, I believe is what they say.
Chairman VOLCKER. I have just been handed the administration
forecasts. It has 11.7, close to 12 percent.
Mr. SCHUMER. Is that not 1982?
Chairman VOLCKER. Oh, that is 1982,1 am sorry, yes.
Mr. SCHUMER. 1983,1 believe it is 10.5
Chairman VOLCKER. 10.5.
Mr. SCHUMER. I gave them the benefit of half a percent.
Chairman VOLCKER. You are correct.
Mr. SCHUMER. Would you say it is more likely, given the other
two figures, that the T-bill rate will be 12 or 13 percent than 11?
Chairman VOLCKER. I am not going to make that fine judgment.
The T-bill rate has moved outside ranges that I thought were likely
in a shorter period of time than that. People would attribute more
prescience to my judgment than it would deserve in that respect.
I think what you can say
Mr. SCHUMER. Well, I will tell you what, I attribute a lot more
prescience to your judgment than to Mr. Stockman's.
Chairman VOLCKER. I have not looked at this closely enough. I
think you can say without equivocation the lower the deficit is, the
better the chances are for getting the rate down. The less pressure
there is on monetary policy for the restraining ingredient, the less
of a problem there will be in terms of interest rates.
I do not think it is out of sight at all. It is not in our normal
projection for a recovery period, but if I had to set a range of likelihood, I do not think I would want to count on growth being that
high next year. I think you could have good growth, however.
Mr. SCHUMER. My time is up. It just strikes me that when Mr.
Stockman in his article in Atlantic Monthly said, well, we sit down
and just basically dream up figures, that he has done a very good

100

job of dreaming up figures and the projections upon which the 1983
budget are based are really sort of dreamt up.
Chairman VOLCKER. Collectively, we have put a lot of strain on
monetary policy in recent years; the cutting edge of restraint has
been monetary policy. That means higher interest rates than you
otherwise would have in the short run. But dealing with the inflation will obviously improve things over a period of time. The longer
that inflation situation lasts, the longer you have the threat of
higher rather than lower interest rates.
The CHAIRMAN. Mr. Frank.
Mr. FRANK. Thank you, Mr. Chairman.
Mr. Chairman, I would like to pursue the question of the administration's attitude toward your policies. And I think this is a case
where politics and policy have really intersected.
Of course, I find when I talk with people there is a great deal of
uncertainty as to what in fact the administration's view toward
you is, and that fact affects the real climate, whether or not they
are pressuring you to change. When the President said he was neutral on whether or not you would resign, that is not simply political rhetoric. Those have impacts on people.
I understand your position. From what you said today—let me
see if I understand it correctly—as far as you can determine, the
administration is quite supportive of the general thrust of your
goals. There may be a little concern, they may think it is possible
to be more technically competent in some ways, but that is not
easy to do from outside—but as far as you are concerned, they are
completely supportive of the thrust of your policies since they took
office?
Chairman VOLCKER. Yes, I believe they said that.
Mr. FRANK. Has there been any communication to you from the
President, from the Secretary of the Treasury, the head of OMB,
the Council of Economic Advisers, that said that you in fact were
too restrictive and that you were interfering with their recovery
plans? Did they make any specific suggestions to you that you
ought to ease up and relax more and accommodate them more?
Chairman VOLCKER. I do not think that comment has ever been
made in a general sense, if I may put it that way, about our policy
over time. You have probably read some complaints in the newspaper—I did on occasion—that in terms of the money supply at times
we were too tight and other times we were too easy.
Mr. FRANK. Are those accompanied or preceded or succeeded by
comments to you, or is that just newspaper talk?
Chairman VOLCKER. It is not just
Mr. FRANK. I do not mean by saying just newspaper talk
Chairman VOLCKER. I mean it is not just newspaper talk in the
sense of some reporter making it up, I presume.
Mr. FRANK. No. But they are saying it for public consumption.
My suggestion is this: Things are not working out as well for this
administration as we had all hoped things would economically, and
I think we are seeing a tendency toward scapegoating, and I think
from time to time you have become one of the scapegoats. And
what I am suggesting is that we see occasionally when things go
bad, when real investment is not projected to be what it was sup-

101

posed to be, somebody takes a whack at you. And I am wondering
whether that is
Chairman VOLCKER. I do not recall any time, just to answer your
question directly, that they have come to me and said you are
being too tight or you are being too easy.
Mr. FRANK. All right. That confirms my sense. I must say I have
to—maybe we ought to get you before Foreign Affairs or Armed
Services, because you have been a great exemplar, I think, of the
policy of unilateral disarmament, because they have been taking
shots at you all year when they think they need to take the heat
off themselves, and you have been quite gracious to them, I think,
frankly, more than I would have been in your place.
But I did think it is important, the suggestion that we get—and
it is more than a suggestion; it comes from within the administration, it comes from Members of Congress who are supportive, from
people in the Wall Street Journal and elsewhere—the suggestion
that the administration is in disagreement and that your monetary
policy has in fact thwarted the hope for recovery has no basis as
far as you are concerned in your communications with the administration?
Chairman VOLCKER. We get comments after the fact that the
money supply has gone up for months. Then comment is why did it
go up for a month? If it went down for a month, the comment is
why did it go down for a month? I wish it did not happen, but those
things are inevitable.
I do not think, to pin down one point which maybe lies behind
some of your questions, that we are going to solve our economic
problems by contemporaneous reserve accounting or floating the
discount rate, for instance. Those are matters of technicality.
Mr. FRANK. So you are saying the technical concerns you have
are not really relevant to the thrust of the problems?
Chairman VOLCKER. I do not think they are relevant to the
thrust.
Mr. FRANK. But what is your reaction as we see from time to
time, as I am sure you have seen, these newspaper comments on
the part of the administration that tend to blame the Federal Reserve Board for the fact that the economy is not performing better?
Chairman VOLCKER. The Federal Reserve has been around for
quite a long time, and I think Congress in its wisdom provided it a
great deal of independence and insulation, perhaps recognizing
that comments of this sort from an administration or from a Congress occasionally arise.
Mr. FRANK. So that you would say that these are part of the political process but do not reflect in any way any fundamental policy
divergence between you and the administration?
Chairman VOLCKER. I am sure that some people in the administration feel very strongly about using some techniques. But in
terms of the fundamental thrust of policy
Mr. FRANK. All right, let me just ask a quick one, if I could.
There is some debate within the administration about deficits. Congressman Kemp has had a religious conversion. He says he no
longer worships deficits. Do you think that the administration as a
whole has a proper concern, given your perspective, for the impact,

102

the negative impact economically of deficits, or are they underplaying it?
Chairman VOLCKER. I wish they had more concern; I think it has
been underplayed, from my perspective.
Mr. FRANK. By the administration?
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Reuss.
Mr. REUSS. Welcome, Chairman Volcker. I want to express my
continued affection and admiration for you and ask a couple of
questions.
Chairman VOLCKER. Thank you. What is coming now? [Laughter]
Mr. REUSS. Last week the Open Market Committee, in the face of
recordbreaking unemployment and record high interest rates,
voted to lower for 1982 the Mi target from the 3.5 to 6 percent,
which the country enjoyed, or did not enjoy, last year to a considerably lower 2.5 to 5 percent.
Was that vote unanimous?
Chairman VOLCKER. No.
Mr. REUSS. Would you elaborate?
Chairman VOLCKER. We voted on all the targets together, so I
would not want to single out any one.
Mr. REUSS. Would you give me the vote of the various 12 members of the Committee on that composite question?
Chairman VOLCKER. 11 to 1.
Mr. REUSS. And who was the one?
Chairman VOLCKER. Mrs. Teeters was the dissenter.
Mr. REUSS. The Treasury has testified within the last week
before both the Joint Economic Committee and this committee that
they would like to see a monetary growth rate in Mi for 1982 of
between 4.5 and 5.5 percent. That is more than double the monetary growth rate for that aggregate for 1981; is it not?
Chairman VOLCKER. It is not quite the same aggregate, but comparing it with the adjusted figure; yes. Comparing it with the unadjusted figure, it is lower, or the same.
Mr. REUSS. Well, but the figures you
Chairman VOLCKER. I think the more appropriate comparison is
with the adjusted figure; but it is not quite the same aggregate.
Mr. REUSS. Your gloss is noted.
In the President's economic recovery program of last February
18, it was set forth, was it not, that the Federal Reserve for the
next 5 years was to successively reduce the growth of the monetary
aggregates? That is on page 18.
Chairman VOLCKER. In general terms, yes, there was some general expression of that kind. You put it in terms of direction; we
make our own decisions on that.
Mr. REUSS. Yes. Are you not getting somewhat mixed signals
from the administration? Did they not, last February 18 and all
along, more recently, say they wanted the money supply growth
figures lowered each year? And are they not now telling you—not
directing you, because you are independent, but telling you—that
they want the monetary growth figures doubled
Chairman VOLCKER. I do not much like the word "telling."
Mr. REUSS [continuing]. Over last year?

103

Chairman VOLCKER. Yes. I think you have to look at these things
in some perspective, Mr. Reuss. As I indicated in my statement, we
would think it probable that we will have higher growth in Mi on
a fourth-quarter to fourth-quarter basis, which depends on whether
each of those particular quarters come out higher this year than
last year.
We expect to have M2 lower this year than last year. M 2 went up
a little last year. We think that structural influences bore upon
both of those aggregates last year and pushed them further apart
and kind of pushed Mi down and the M 2 up a little bit from our
original intentions.
I think if you look at the results over a period of time, the downward course has been apparent in the past and I think it will continue to be apparent in the future, even if Mi is higher this year
than it was last year.
Mr. REUSS. Well, is not Mi the most commonly used aggregate?
When Secretary Regan, for instance, talks about money, is he not
talking about Mi?
Chairman VOLCKER. I do not know what he is talking about. He
may often be talking about Mi. When I talk about money, I have
got more than Mi in mind. I think it is fair to say that what is
most commonly used is probably Mi, but a lot of people think that
M2 is more relevant. I would say let us look at both of them and let
us look at other information that we have, because that is necessary in interpreting what happens to any single one of them.
I think it would be a great mistake to put all our money in one
basket and let whatever forces impinge upon that one number,
which may give you an odd reading, dictate policy. That seems to
me inappropriate. During a situation particularly of the kind we
have now, we know you can go out and talk to people in the
market about how their cash management practices changed because of the introduction of technology. We had better look at more
than the number that is most sharply affected by that technology.
M 2 has performed quite reliably in recent years—we have not got a
very long growth pattern—relative to nominal GNP, for instance.
Mr. REUSS. Then is it your testimony that you do not feel you
have been getting misleading signals from the administration, from
an administration which consistently regards Mi as the most important aggregate and from an administration which has consitently urged the lowering of the monetary aggregates in 1982 over 1981
and in 1983 over 1982, and so on, world without end?
You do not feel you are getting an inconsistent signal when they
come up here and testify, as they did
Chairman VOLCKER. You may
Mr. REUSS. If I can just finish—as they did twice last week that
they want you to produce a 4.5 to 5.5 percent, which is more than
double the Mi increase of last year? Do you not feel put upon at
all?
Chairman VOLCKER. I guess, you know, in the context of being
put upon and getting signals and all the rest, I start from a different position, Mr. Reuss. We make up our mind on these things, and
I do not hang around trying to read the entrails of some statement
that the administration may make, because it is our responsibility
to make up our minds about these things, and we do so.

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Mr. REUSS. You do, however, read the President's economic recovery program.
Chairman VOLCKER. Surely. But I mean that I don't go back and
compare what they said before to see whether it is consistent or inconsistent with what us said now. Forget about what the administration says for the moment.
I say in my statement that we would think it likely this year
that Mi—just looking at that single aggregate on a fourth-quarter
to fourth-quarter basis—will increase more than it did last year. It
only increased by 2.3 percent last year. As I suggested, looking at
what we know now, we would find an increase in the upper part of
the range acceptable. That would be a bigger increase measured in
that manner than we had last year for that particular aggregate.
I do not find that at all inconsistent with the basic thrust of our
policy. I suppose you would expect me to say that, but I do not.
And I suppose they would not find their comments inconsistent
with the basic thrust, because I think we are in agreement on the
basic thrust.
Mr. REUSS. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Stanton.
Mr. STANTON. Thank you very much, Mr. Chairman.
I simply want to pass on to you, Chairman Volcker, thanks on
behalf of the entire committee. We always look forward to your testimony.
A couple of observations that I would make. Probably today was
no different than what has taken place every 6 months in that the
majority of the questions are often politically motivated.
And it does remind me of being home in Ohio last week and talking to an unemployed friend of mine, when he said, you know, I did
not vote for that Reagan and I am not going to vote for him again.
But, he said, if you ever get a chance to tell him something, he
said, you tell him I am hoping and praying that you will go along
with his program to the extent that if he succeeds, I am going to
succeed and if he does not succeed I am sure there is no hope for
me. And that is the underlying political position that we are in at
the present time.
Let me just ask you something else in observing your testimony
today. I sensed a sense of optimism to a degree that has not been
present before. And I was looking for a reason for this, and it
seemed to me that you did say something significant when you said
that you did sense a fundamental shift in inflation. And we obviously know it is down, but it could be very, very significant. And
this would be, to me, a very far-reaching thing as far as long-term
bond markets are concerned.
Do you think that perhaps you see something there that is a very
different shift?
Chairman VOLCKER. If you were to interpret my comments as optimistic, I think you have put your finger on the source of it. Getting the inflation rate down simply because we are in a recession is
no achievement of any lasting import in and of itself. The question
is whether we can see forces in the economy that promise to offer
the prospect that inflation can continue to come down as the economy expands, and I do think we are beginning to see that.

105

I do not want to overplay it. We are going to have to see it in
new contract settlements, for instance, in labor. We are going to
have to see it in the nature of those settlements and of work practices and of potential productivity improving. It is much harder to
measure what emphasis management itself is putting on production, as opposed to more peripheral activities to the health of the
economy.
But I do think you can begin to see that going on, and I think
clear evidence relatively recent, frankly. It is only just beginning to
show up in the figures to any extent. I do not want at all to suggest
that we are on a clear downward slide on the rollercoaster of inflation. But I do think if we stick with this—and that has monetary
policy implications, implications for the deficit and for fiscal
policy—if we stick with it, we may be able to look back and say
this was the turning point on this insidious inflation, on the low
productivity, on the ratcheting up of the unemployment rate that
went on with it. That is what we are dedicated to.
Mr. STANTON. School is still out? Thank you very much.
Thank you, Mr. Chairman.
The CHAIRMAN. Congressman Neal.
Mr. NEAL. Thank you, Mr. Chairman.
Chairman Volcker, you detected a note of politics in my last
question, and let me try to rephrase a couple of those questions in
a neutral vein, if I could, because to me, anyway, they are important questions because I am trying to understand how our economy
works.
But it seems to me that we can attribute the reduction in inflation that we have been seeing clearly over the last couple of years
primarily to policies of limiting money growth begun a couple of
years ago.
Chairman VOLCKER. I think that is largely fair. We have had
some breaks in the oil situation that helped it along.
Mr. NEAL. Well, I was going to add that we can attribute then,
especially by another measure, we can attribute much of the rest
and probably the balance of that progress to some luck in oil prices
and some luck in food prices and some reduction in import prices
because of the strength of the dollar.
You could explain probably all of it or 90 percent of it in those
terms. And would you generally agree with that?
Chairman VOLCKER. I think I would generally agree. Let me
point out that a lot of people talk about oil prices being something
different from our policy or even from food prices. There are elements, maybe large elements that are extraneous, but, on the other
hand, what the dollar is doing internationally as well as domestically, and the level of interest rates, both affect oil prices as well as
other product prices.
Mr. NEAL. Well, I think that is true, but I guess what I am getting at is it seems to me that these changes in the rate of inflation
are largely due to policies that were begun, in the case of Fed
policy, back in the fall of 1979, maybe some would say in the fall of
1978. And there was a noticeable change in direction and with oil,
you can attribute some of the stabilization of the price of oil to
those policies, you might attribute some of it to decontrol.
Chairman VOLCKER. That is right.

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Mr. NEAL. Well, decontrol took place several years ago. I just do
not want it to be a part of the permanent record that somehow
these prospective cuts in aid to the disabled and the blind and the
hungry and so on, that somehow that becomes a permanent part of
the record that that is what has turned the corner. I do not think
that argument can be sustained.
I think the President is fair in saying that he is not responsible
for the situation in 1981. In other words, he cannot take credit for
the rate of inflation in 1981, and he probably should not be blamed
for a large part of the recession.
Now, I think you have answered that question clearly. You agree
with me on that point. You would not put in the political terms, I
understand that. But I am trying to look at objective facts and get
away from the politics at this time.
The recession, it seems to me, clearly has been caused by the
same policies, like it or not. I am not trying to place any blame; I
am just saying that there has been a change in expectations, and a
whole range of other considerations has resulted in part of that.
It does seem to me, though, the reasons for the continuing recession and the continuing high interest rates are something else. I
would like to ask you a question about this, if I may. It seems to
me that the continuing high interest rate, historically high real interest rates, are the result of uncertainty, lack of confidence, fear
of the future. They are not related directly to what one would
think they would be related to; that is, the rate of inflation. Is that
not essentially true? Is that not what is going on? Or am I missing
the sense of this?
Chairman VOLCKER. I think there is a large element of that. I
would want to supplement your answer. I think you focused particularly on long-term rates, and they are certainly influenced by
the factors you mentioned. They are influenced by their own instability in recent years, which is a bad thing in and of itself, in my
opinion.
Long-term rates, particularly in this situation, are not insulated
from short-term rates. I think we have to face the fact that if the
main brunt of the restraining effort and the anti-inflation effort
falls so heavily on monetary policy, you are likely to get higher
short-term rates than you otherwise would have. That is a factor in
this situation.
Mr. NEAL. My time has expired. May I just ask two yes-or-no
type questions?
The CHAIRMAN. Surely. In fact, why don't you just take the
chair.
Chairman VOLCKER. They do not have to be yes-or-no questions.
[Laughter]
Mr. NEAL. Mr. Chairman, I do appreciate that. I will not try to
carry on too long. We do have a vote, and that sort of saves the
day.
So it seems to me then, if I understand your answer, that you are
agreeing again that at least some of the reasons these historically
high, especially long-term rates, is this uncertainty, this element of
fear.
Chairman VOLCKER. Yes, I agree with that.

107

Mr. NEAL. It does seem to me that much of that is triggered by,
as you said in your testimony, the view that there will be large and
increasing deficits, increasing in size for a number of years to
come.
Chairman VOLCKER. Yes.
Mr. NEAL. And I guess this question, which I would like answered yes or no, if I could get it, would be: Would it not be more
important to the long-term health of our economy for us to give a
higher priority to reducing those deficits, if this is what it took,
than to continuing the tax cuts? Is it not a more important question, or is it reducing the deficit more important than reducing
taxes?
Chairman VOLCKER. If you put it as generally as reducing taxes,
I think I would agree with you. But I do not want to give a yes-orno answer. It is the same question I think Mr. Schumer asked
about a particular tax cut; that is not the only alternative.
Mr. NEAL. I am not asking that.
Chairman VOLCKER. I would say, if you cannot do it on the
spending side, for whatever political, social, defense, security, or
whatever reason, then I think you have got to look on the revenue
side.
Mr. NEAL. One last question, if I may. And that is, when I asked
you the question about velocity, I was trying to get at the potential
for growth in the economy. And I was not asking a question about
month-to-month changes and so on. The question I was asking is,
Could velocity ever, over a sustained period, year over year, be
high enough to bring about that kind of growth in the economy if
you were to hit your targets for Mi?
Chairman VOLCKER. If you were on Mi alone
Mr. NEAL. Yes, sir.
Chairman VOLCKER [continuing]. You would be very unlikely to
get that kind of sustained growth and velocity unless there is some
technological change going on. If the money market funds take
over the world and we do not include them in Mi, that is a different story, but there can be other kinds of technological changes.
Mr. NEAL. Again, I guess that leads me to the conclusion that it
is very unlikely that we are going to hit that kind of economic
growth if you hit your targets; and if we do not get that kind of
economic growth, it seems unlikely that the other projections for
the deficits, for savings, for all of these other things are unrealistic.
Chairman VOLCKER. We expect the money supply to be declining,
but our targets basically are directed toward sustaining the progress on inflation.
Mr. NEAL. And I agree with that, certainly.
Chairman VOLCKER. Yes, I am sure we have no disagreement.
Let me state it positively, as I suggested in my statement: I think if
we do this right, which is not just a question of monetary policy,
we can look forward to a long period of economic expansion consistent with a declining inflation rate.
Whatever money supply targets we come up with in subsequent
years, I would say, would be consistent with that declining inflation rate.
Mr. NEAL. Mr. Chairman, we have had the second bell on a recorded vote.

108

Mr. PATMAN. I am just being paired, Mr. Chairman.
Mr. NEAL. Pardon me?
Mr. PATMAN. I am just being paired on that vote, so I am going
to miss that one.
Mr. NEAL. All right. Well, would you take the chair so that I
might answer the vote?
Mr. PATMAN. Surely.
Mr. NEAL. Mr. Chairman, thank you very much.
Chairman VOLCKER. You are welcome.
Mr. NEAL. You have certainly helped me in understanding our
economy and giving us some guidance by answering these questions.
Chairman VOLCKER. This is not a new statement, but the more
progress we make on inflation, the more room you have for growth
within those targets.
Mr. NEAL. Well, Mr. Patman is on his way. Let me ask you this.
Why is it necessary to keep the discount rate at 12 percent when
we have the Federal funds rate at 15 or so?
Chairman VOLCKER. That is a great mystery to many people, and
I understand why it is.
Mr. NEAL. Does it not encourage banks to come to the discount
window to borrow?
Chairman VOLCKER. We put banks on kind of a leash when they
come to the discount window. The trouble is, if you raise the discount rate, market rates will go up. That may be good or bad, but
that is the consequence of
Mr. NEAL. Short run.
Chairman VOLCKER [continuing]. Short-term rates. And raising
the discount rate in today's market could easily affect long-term
rates.
Mr. PATMAN. Mr. Volcker, I have just a few more questions.
With respect to the economy of the United States, how close is our
country to a national calamity? [Laughter.]
Chairman VOLCKER. I do not think we are on the verge of any
national calamity, Mr. Patman. I think we would eventually get to
a calamity if we had let the earlier trends in inflation continue unchecked.
Mr. PATMAN. You do not see any likelihood of a sharp increase
in the bankruptcies of banks, for example, or the insolvency of
those banks?
Chairman VOLCKER. Of banks? No.
Mr. PATMAN. Savings and loans?
Chairman VOLCKER. We are having a sharp increase of problems
in the savings and loan industry.
Mr. PATMAN. Do you anticipate that will increase or remain the
same at projected level of increase?
Chairman VOLCKER. It will be a continuing source of difficulty at
these levels of interest rates.
Mr. PATMAN. How soon do you anticipate that interest rates will
decline?
Chairman VOLCKER. I would like them to decline as soon as possible, but I just do not engage in the game of trying to give a precise
forecast on that.

109

Mr. PATMAN. Have you noted the high increase in personal bankruptcies?
Chairman VOLCKER. For several years. That is partly related to
the new bankruptcy law, and you cannot distinguish the two. But
certainly, they are running high, historically.
Mr. PATMAN. And you have noticed a sharp increase in business
bankruptcies?
Chairman VOLCKER. Yes.
Mr. PATMAN. Those do not indicate to you that we are heading
toward some real crisis in the economy?
Chairman VOLCKER. No. They indicate a lot of problems out
there.
Mr. PATMAN. But nothing of great concern?
Chairman VOLCKER. They are of great concern.
Mr. PATMAN. Do you feel like lower interest rates would be of
assistance to those problems, in solving them?
Chairman VOLCKER. Those particular problems? Yes.
Mr. PATMAN. And to what extent would you equate the deficit
and the projected deficits as to their contribution to higher interest
rates?
Chairman VOLCKER. I think it is an important factor.
Mr. PATMAN. Fifty percent or seventy-five percent?
Chairman VOLCKER. Fifty percent of what?
Mr. PATMAN. Fifty percent of the probability or what?
Chairman VOLCKER. Of the probability of what?
Mr. PATMAN. If you took all of the factors into consideration on
what caused high interest rates, would you give high deficits a very
large portion of that contribution?
Chairman VOLCKER. I simply cannot give you a quantitative estimate of that sort.
Mr. PATMAN. How much of our present unemployment has been
caused by high interest rates?
Chairman VOLCKER. That is an unanswerable question, Mr.
Patman. What is the alternative that you present? If you present
an alternative of interest rates half as high and everything else the
same and inflation continuing to come down and everything else
very nice, you would say a very high percentage.
But that is not the alternative we are faced with.
Mr. PATMAN. Irrespective of the alternatives, just considering the
present situation, how much of the present rate of unemployment
is caused by
Chairman VOLCKER. I do not think the question is answerable.
Mr. PATMAN. Well, just give me the best you can on it.
Chairman VOLCKER. It carries the implication that I have got to
compare it with something. What am I comparing it with?
Mr. PATMAN. Well, do high interest rates cause high unemployment?
Chairman VOLCKER. High interest rates cause difficulties for
business and, of course, difficulties for home buying; they cause difficulties for other industries, and in that sense, they contribute to
unemployment. But that is not the whole story. The question is
how to get those interest rates down.
Mr. PATMAN. Well, I know, but without respect or regard to what
you get into on that, I just want to know the effect of the higher

110

interest rates. And you do think that they do cause unemployment,
do you not?
Chairman VOLCKER. The fact is that we came into the grip of a
great inflation that had to be dealt with. We are in a recession
now, but unemployment did not begin 6 months ago; we have had
an adverse trend of unemployment for 10 years.
Mr. PATMAN. But the question, Mr. Volcker, is not what caused
the high interest rates. The question is do high interest rates cause
unemployment?
Chairman VOLCKER. The question phrased that way is unanswerable.
Mr. PATMAN. Well, in other words, you do not think you can say
whether high interest rates do cause unemployment or do not
cause unemployment?
Chairman VOLCKER. You have to ask me what lies behind high
interest rates, whether you have an alternative, what the situation
would otherwise be and what unemployment would be in other instances. I cannot give you the answer to all those questions. If I
could get interest rates down and everything magically improved, I
would do it.
Mr. PATMAN. It seems like that would certainly be a part of your
statement on page 16 when you say, "I referred on many occasions
to the key importance of winding down the cost-and-wage pressures
that tend to keep the inflationary momentum going/'
From the standpoint of the inflationary momentum and judging
what cost means, is not, of course, a high interest rate a cost?
Chairman VOLCKER. Yes.
Mr. PATMAN. And so you would want to wind them down, too?
Chairman VOLCKER. Yes.
Mr. PATMAN. And so high interest rates do contribute along with
wages to inflationary pressures?
Chairman VOLCKER. Not on balance, but they are a cost element.
On balance, they do not contribute to inflation, in my opinion.
Mr. PATMAN. Well, on balance. But taken by themselves
they
Chairman VOLCKER. They have other effects. Taken by themselves, I do not think
Mr. PATMAN. Taken by themselves, they do cause and do contribute to inflation, do they not?
Chairman VOLCKER. They do contribute to the costs.
Mr. PATMAN. And costs contribute to inflation?
Chairman VOLCKER. They are one factor contributing to inflation. But interest rates have other effects as well that are offsetting.
Mr. PATMAN. You mean they have beneficial effects as well as
detrimental?
Chairman VOLCKER. They do that
Mr. PATMAN. Is that what you are saying?
Chairman VOLCKER. They do on inflation, yes.
Mr. PATMAN. They do what?
Chairman VOLCKER. They do on inflation.
Mr. PATMAN. They have a beneficial effect. Well, do you not recognize then that interest rates contribute to inflation?
Chairman VOLCKER. No.

Ill
Mr. P ATM AN. You do not? You deny that?
Chairman VOLCKER. I deny that in a balanced view, yes. I think
they are an element in costs.
Mr. PATMAN. Well, Mr. Volcker, several people who have asked
questions today have related to and have stated that the housing
industry is going broke, the automobile industry is going broke,
businesses throughout this country are suffering because of high
interest rates.
I think that is true, and I think that damages the very structure
and strength of this country. And I just want to tell you that there
will not be any demand for blood after all the patients have died.
Chairman VOLCKER. In general terms, I agree with the statement
that high interest rates create a lot of problems in the economy.
But the relevant question is how we get them down.
Mr. PATMAN. I do want to encourage you to work with the administration in coordination closely with them and those members
and see if you all can get a coordinated policy going that you can
agree on that will not cause inflation and not cause this high unemployment.
Chairman VOLCKER. That is the objective. We have no disagreement about that.
Mr. PATMAN. Well, do you then tell us that you have worked in
close harmony in the last year and a half or the last year?
Chairman VOLCKER. We worked with them and we have been in
harmony on the objectives of monetary policy.
Mr. PATMAN. Evans and Novak in one of their columns said that
you are a Democrat. You do not claim to be a Democrat, do you?
Chairman VOLCKER. I was registered as a Democrat the last time
I was registered with a party affiliation. I do not think it is appropriate to register with a party affiliation in my present job.
Mr. PATMAN. Right. Well, had you ever been registered as a Republican?
Chairman VOLCKER. No.
Mr. PATMAN. Did you vote for President Carter last time?
[Laughter.]
Chairman VOLCKER. I think there are limits to how far I will go
in this direction, Mr. Patman.
Mr. PATMAN. In your past experience as a holder of political
office, the highest job you held, prior to the one to which you were
appointed by President Carter, was one to which you were appointed by President Nixon, was it not?
Chairman VOLCKER. Yes.
Mr. PATMAN. Unemployment is, as we have all talked about, at a
very high level
Chairman VOLCKER. I had been appointed to public office, if it
helps any, in the Kennedy administration, the Johnson administration, the Nixon administration, and the Carter administration.
Mr. PATMAN. I am sorry, I did not mean to interrupt your statement there. What was it?
Chairman VOLCKER. I was just repeating all the administrations
in which I have been appointed to public office.
Mr. PATMAN. We have all talked about unemployment, and I
have, and people here today have, and about its being at a very

112

high level. If that high level continues to rise, is there a level at
which you would decide to change from a high interest rate policy?
Chairman VOLCKER. I do not describe our policy as a high interest rate policy. I do not describe it as an interest rate policy. We do
restrain growth in money and credit.
Mr. PATMAN. If you have a high interest rate in existence in the
country, does that tend to depress the level of money and
credit
Chairman VOLCKER. Yes.
Mr. PATMAN [continuing]. The money and credit supply?
Chairman VOLCKER. All other things equal, yes.
Mr. PATMAN. Sir?
Chairman VOLCKER. All other things equal, it would tend to depress the growth in money and credit. It would not depress the
supply of savings. It would tend to dampen the growth in money,
all other things equal.
Mr. PATMAN. And in fact, when we are talking about the money
supply, we are really talking about money and credit supply, are
we not?
Chairman VOLCKER. There is a large overlap in the concepts, yes.
But we are not talking about savings, and that is the key distinction. The Federal Reserve can facilitate the creation of money. We
cannot create savings. Real investment has to come out of real savings, not out of money.
Mr. PATMAN. I hate to take too much of your time, Mr. Volcker.
Other members have gone to the floor, and if you care to make a
closing statement, please do so.
Chairman VOLCKER. I do not. I think we have pretty well exhausted the subject this morning, Mr. Patman. [Laughter.]
Mr. PATMAN. If there are no further questions, the committee
stands recessed, subject to the call of the Chair.
Thank you, sir.
[Thereupon, at 2:02 p.m., the committee was adjourned, subject to
the call of the Chair.]

CONDUCT OF MONETARY POLICY
TUESDAY, MARCH 30, 1982.

HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met, pursuant to call, at 10 a.m., in room 2128,
Rayburn House Office Building; Hon. Fernand J. St Germain
(chairman of the committee) presiding.
Present: Representatives St Germain, Reuss, Gonzalez, LaFalce,
Evans of Indiana, Vento, Barnard, Schumer, Patman, William J.
Coyne, Stanton, Wylie, Evans of Delaware, Shumway, Parris,
Weber, Carman, and Roukema.
The CHAIRMAN. The committee will come to order.
This morning we will resume this committee's hearings under
the Full Employment and Balanced Growth Act. Last month we
heard from Chairman Paul Volcker of the Federal Reserve Board.
Today's first witness is our distinguished majority leader, James
Wright, better known as Jim, of Texas, who has been an outspoken
critic of the current tight money high interest policy.
Jim Wright has dramatized in a highly articulate manner the
pain and suffering that this prolonged period of high interest rates
had inflicted on the small businessman, the worker, the farmer,
the prospective home buyer. He represents a Democratic leadership
that has deep concern about what high interest rates are doing to
the basic economic fabric of this Nation.
So, we welcome you this morning, Mr. Majority Leader, and we
will ask you to proceed as you will. If you have a prepared text, we
will introduce it in the record, and you may proceed as you will.
STATEMENT OF HON. JIM WRIGHT, A REPRESENTATIVE IN THE
CONGRESS FROM THE STATE OF TEXAS AND MAJORITY
LEADER OF THE HOUSE OF REPRESENTATIVES

Mr. WRIGHT. Thank you very much.
What you are doing today is probably the single most significant
thing being done in the Capitol today. There is not another item in
the economic agenda more important than finding a way to reduce
these devastating interest rates.
There is not a single more hurtful thing in the economy than the
high and sustained level of interest rates, which have stifled the
growth of new enterprise, which have prevented the stimulative
tax policies of the administration from performing their intended
work, which have thrown many people out of work, which have
made it almost impossible for a young couple to buy a home, which
has caused devastation in the homebuilding and automobile and

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thrift industries, and which threaten, if not halted and reversed, to
plunge us into the depths of a recession such as we have not experienced in this country since the days of the Great Depression.
I don't think that there is any question but that the policy deliberately pursued by the Federal Reserve Board, resulting in higher
interest rates than this country ever has suffered, is responsible for
the increase in unemployment.
There can be no question that it is responsible directly for the
sharp decline in automobile sales and manufacturing in the United
States and for the home building industry.
These two industries, home building and automobiles, together
with the spinoff effects that they have in the secondary employment factors, or people who are engaged in lumbering, appliance
manufacturing, manufacturing of rubber and tires and other accouterments related to automobiles, probably account for one job in
every four in the United States.
So, when home building and automobile sales decline at the rate
that they have declined, then it is very difficult to begin or to sustain any kind of a revival in the economy.
We know, of course, what has happened with regard to homes. A
young couple 5 or 6 years ago seeking to purchase a $50,000 home,
which was not then and surely is not now a mansion, and amortized that over a period of some 30 years would have had to pay
approximately $433 a month in their monthly payments. Many, if
not most young couples, could afford that sum.
Today, however, if they could purchase that house for $50,000,
which probably they could not—let us say whatever house they
could purchase for $50,000, a lesser dwelling—amortized over the
same 30-year period would cost them not $433 a month but considerably more than $800 a month. Their monthly payments would
just about have doubled.
For those monthly payments they get less than they would have
gotten. For the first several years, that $800 plus a month buys
them no equity. It is spent for the dubious privilege of borrowing
the money only. Now they can't afford it. Most young couples
simply can't afford that.
An average priced new home, to be amortized over 30 years,
probably costs very close to $1,000 a month. The National Association of Homebuilders estimates that only 3 percent of America's
newly emerging family units, only 3 percent, can qualify to buy a
new home in the markets of the United States today.
What is happening, of course, is that these devastatingly high interest rates are in the process of killing a very important part of
the American dream.
We set out as a nation to differ from other countries in two or
three important respects, but the most important one I think was
that instead of creating an aristocracy, a landed gentry, composed
of a few people who were born to it and to which others were forever denied, we deliberately decided that we were going to create
the possibility of continued upward mobility. We were not going to
have any ceilings on aspirations of what people could do. We were
going to make it easy for more people to get a piece of the action.
So, in that regard we were not like some of our European ancestors, nor indeed were we like the French Revolution or the revolu-

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tion which sought to destroy the aristocracy and installed in its
place a dictatorship of the proletariat, reducing everything to the
lowest common denominator.
That wasn't our goal, either. Our goal was to expand the aristocracy, to expand the landed gentry, to make everybody a potential
capitalist, to have a nobility to which all could aspire and most,
indeed, could attain.
That was the American dream, that a family, an average family,
not just a wealthy family, but an average family, and indeed a
family of modest circumstances, would be permitted to own its own
home. That dream is going out the window very rapidly because of
high interest rates.
So far as automobiles are concerned, everybody is familiar with
the term 'sticker shock'. Anybody who has gone to an automobile
dealer with a dream of buying a new car has experienced sticker
shock.
The appalling thing is that now amortizing those automobiles
over a 5-year period, not really knowing whether the car is going to
be worn out at the end of 5 years or not, a young couple or a young
person attempting to buy a car, or a middle-aged person, a person
of medium means thinking about buying a new car can confront
the reality that in order to pay for that car he or she is going to
have to pay as much monthly as just a few years ago he or she
would have had to pay for a home.
Now, I suggest that that is just absolutely ridiculous. As a consequence of all this, of the interest rates which have driven people
out of the home building market and out of the automobile purchasing market, and which have shriveled the net worth of many,
many farms and many, many thrift institutions, which are probably now causing more farm foreclosures than we have seen since
the Great Depression, let's see if we can quantify it.
During the first 10 weeks of this year, from January 1 up to
about the end of the first week in March, approximately 5,000 businesses have failed. They have closed their doors in the United
States. The average is 486 a week, 486 business failures a week.
Most of these are small- and medium-sized businesses, but since
the beginning of this year 99 industrial plants have closed. That
many we know about by having read the newspapers.
I am going to have a chart, a map of the United States that I am
going to show on the House floor either later today or at some
future time in which I am going to show where plants have closed
in the United States, just since the beginning of this year. We
know of 99 that have closed, and we know, as a result of that, of
some 150,000 layoffs that have occurred.
All in all, some 500,000 workers, some 500,000 Americans have
been added to the Nation's unemployment rolls since the beginning
of this year because all of the different layoffs, of all of the different restrictions, all of the different plant closings, all of the different small businesses that have gone out of business, about a half
million people thrown out of work.
I think more than any other single cause that has contributed to
that, we have to look to the high interest rates, which have continued at an unwarranted, unconscionable and inexplicable level.

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If high interest rates continue, one can only expect those numbers to grow. I know it is going to be said by some that these high
interest rates have begun to curb inflation, but I don't really believe that is the case.
I do know that inflation has begun to fall at an appreciable rate,
and I think we all need to be grateful for that. But we cannot look
to the inflation factor alone. We must remember that we didn't
have any inflation problems at all during the Great Depression,
and yet people were suffering. People were out of work. The economy was staggering before collapse.
It seems to me instead that the decline in the inflation rate
today is a desperate last gasp of an economy that is reeling from
these continued blows of high unemployment rates.
The gross national product, adjusted for inflation, has dropped
this year to a negative 4.5 percent. GNP is not rising. The economy
is not growing, as the President suggested when he advocated 1
year ago this month, in March of 1981, the kind of tax bill which
he thought was going to create the flow of the stimulative juices of
the free enterprise economy and stimulate more investments in
those kinds of enterprises that would create jobs.
Unfortunately, it just didn't work. The President said in March
of last year, these were his words, 'Immediately upon passage of
this tax reduction we will see a sudden upturn, a sudden upturn in
the economy."
Those are the words of Mr. Reagan, and I am sure he believed it.
The tragedy is that what we saw was precisely the reverse. We saw
sudden and continued downturns beginning in August, the very
month that we finally passed the tax cut.
Well, what happened? Let's say that the tax cut was intended as
a stimulus to business investment. I am sure it was. I am sure that
those who engineered it had a logical rationale in their minds and
good intentions. They wanted to create investments in the American economy that would create more jobs.
The trouble is at the same time, because it portended such astronomically high deficits, nobody believed that it was going to improve the economy, nobody felt that it was going to be justifiable to
take this money that was showered upon those at the top of the
economic pyramid and invest it in new job-creating enterprises.
People didn't invest that money, unfortunately, in anything that
was speculative, in anything that would be inclined to improve the
job base of this country. What did they do? Well, they put it in
money markets or they put it in certificates of deposit and enriched themselves and enhanced their own economic position.
Or some people, some companies may have used it to finance
more mergers. Those mergers in turn, rather than creating more
employment created higher unemployment. So, that has been the
result.
It was as though we had gone out in the forest at night, shivering from the cold, trying to create a little fire by which we could
warm ourselves. Laboriously we went out and gathered a few sticks
and a few twigs and a few leaves and we husbanded them very
carefully.
These leaves and twigs and sticks were the elements of the tax
cut, which was supposed to stimulate an economic recovery. Then

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we took our match and carefully lighted the fire and blew on it
carefully until it was just about to ignite. Then there came a great
rainfall and put it out. The rainfall was the high interest rate.
You have had two policies of the Government fighting one another. You have had the so-called supply side theory of releasing
this money into the private economy to create more investments,
and on the other hand you have had this kind of an exercise that
old Charles Atlas used to teach you. Use one muscle to build the
other muscle. The trouble is the muscle that has been weak is not
the supply side muscle, it is the monetarist muscle.
The monetarists, fighting the supply siders in the same economy
and in the same administration, have just absolutely won the day.
Paul Volcker, elected by no one, approachable by no one, removable by no one, apparently, not amenable to discussing things with
anybody, has singlehandedly and through his influence put at
naught what the President of the United States and people in Congress—who I think at the time were ill-advised in voting that tax
cut, but nevertheless well-intentioned—intended to do.
Let me show you just a couple of charts because I would like
very much, if I could, to dispel some myths about the idea of interest rates being anti-inflationary. I think they are the most absolutely inflationary things that we could imagine.
I wish this chart went back to the forties because it shows a consistent pattern, since World War II. The pattern that it demonstrates is that inflation follows rather than precedes high interest
rates. Let me say it again another way. High interest rates are like
pouring gasoline on a fire. They don't curb inflation, they feed inflation.
Here, from 1970 until 1981, an 11-year period, we have a line
that represents the prime interest rate and a blue line that represents inflation, as represented by the implicit price deflator.
In every instance, when the prime rate began to come down it
was only a little while until the inflation rate began to come down.
A rise in the prime rate preceded, in 1973, a rise in the rate of inflation.
The prime rate peaked in 1974. Inflation peaked about a year
later, 1975. Here at one point the prime rate was even below the
rate of inflation, while it was catching up. But then, here in 1979,
the prime rate again began to rise, and we see this rise in the inflation rate.
Now, we have seen a leveling off in the inflation rate. These last
few months show that. It may have had something to do with a leveling off in the prime rate, although it has not been appreciable.
The second thing I want to show to you, however—and I do wish
that I had a chart which represented a longer span of years because it would be even more dramatic—is that over the years,
historically, certainly in the economies that have existed in the
United States since 1946, the end of World War II, the prime rate,
the rate that lenders reserved for their best customers, has hovered
just ahead of but only something like two or three percentage
points at the most above the rate of inflation, somewhere between
2 percentage points and 3 percentage points difference.
Historically this is true. This would go back for 30 years or 20
years prior to 1970. Historically the prime rate has shown only 2 or

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3 percentage points above the inflation rate. That has been a premium that everybody has agreed money was worth.
Well, look what is happening now. You can extend this line for
another third of a year and it would tell the same story, spread the
gap along prolonged spread of interest rates hovering about 10 percentage points above the rate of inflation.
Nothing could be more dampening on the economy. Nothing
could cause this so-called economic recovery to be stillborn in a
more effective way.
Now the second thing I want to show you is that not only do
high interest rates not help with inflation, but they cause inflation
by adding an extra cost at just about every layer of the marketplace. They cause depression. They cause unemployment. They precede unemployment.
The prime interest rate has been a precursor of the unemployment rate. In this same 10-year period you can see that as the
prime rate went up, beginning in 1972, the unemployment rate
started going up behind it. The prime rate peaked in 1974 and the
unemployment rate peaked shortly thereafter, 1975. Then it came
down.
Now, the prime rate kept going up until unemployment in desperation began going up. In 1980-81 it went up some more and now
1982 it is up a little bit more yet, to about 9.5 percent.
Well, what does that tell us? It tells us, I think—and I believe
that an extension backward of this map to 1945 or 1946 would tell
us even more emphatically that whenever you have high interest
rates, you are going to have more unemployment.
Now, let me ask you to examine one other statistic with me.
Someone may say—and I am sure Mr. Volcker truly believes that
it is justifiable for him to control the interest rate and keep it high
by means of controlling the money supply and keeping it tight and
restrictive—that that is going to help the inflation rate. I think he
is sincere about that. But let me show you a little chart here.
This is a chart that may look more exaggerated than it really
ought to, but it traces the money supply as a percentage of the
gross national product.
In 1970, Mi, the money supply was 22 percent, right at 22 percent of the gross national product. In 1971 it was 21 percent of the
gross national product, the money supply. In 1973 it was 20 percent. In 1975 it was between 18 and 19 percent, it was 18 point
something percent. Now, today, in 1981, it is 15 percent, down from
22 percent of the gross national product to 15 percent of the gross
national product.
This chart simply suggests to me that the Federal Reserve Board
has been unduly restrictive in its zeal to suppress the money
supply. In suppressing the money supply, it has not materially
brought down the rate of inflation, except as a byproduct of having
created higher than necessary interest rates, higher than warranted, and therefore creating higher unemployment than this Nation
can stand.
Now, Mr. Chairman, that concludes my initial testimony. I appreciate the privilege that you have given me to come and say
these things. It just seems to me that there is not a single thing
that this Congress could do that would be more effective in turning

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around the recession than by doing something effective to bring
down interest rates and keep them at a livable level for a predictable period of time.
The CHAIRMAN. Thank you, Mr. Majority Leader.
At this time I would call on the chairman of the Joint Economic
Committee, who would like to discourse with you, Henry Reuss.
Mr. REUSS. I will be very brief.
You have made an excellent analysis, Mr. Wright. Would you
agree with me that when the administration and the Federal Reserve are pursuing policies which lead to disastrously high interest
rates, such as you have described, that it is not only the right but
the duty under the Constitution of Congress to tell the administration and the Federal Reserve that they must change those policies?
Mr. WRIGHT. I most emphatically do, Mr. Chairman. I don't
think we can abdicate that responsibility. Too long have we hidden
behind the notion that we don't have anything to say about the
Federal Reserve, that is their business, let them take care of it as
best as they can and we will blame everything on them.
I don't think we can afford to do that any longer. I think we
have responsibilities to the public. We are elected by the public,
after all. The Federal Reserve isn't. We are answerable to the
public, after all. The Federal Reserve isn't. I think we have that
responsibility.
Mr. REUSS. Thank you. You said it all, as far as I am concerned.
The CHAIRMAN. Mr. Stanton?
Mr. STANTON. Thank you very much, Mr. Chairman.
Mr. Majority Leader, we welcome you once again before our committee. I asked the chairman a minute ago if you ever served on
our committee. You do have a great interest in this subject, and I
was just curious. He said that he doesn't think you ever did.
Mr. WRIGHT. I never had that privilege, Mr. Stanton.
Mr. STANTON. The thing I liked about your remarks, really, was
that they were fundamentally nonpolitical. They address the problem primarily of the responsibilities on the Federal Reserve Board,
the culprit of high interest rates.
I always thought Congress could come in somewhere for a little
bit of the blame in the economy and the country. We do some
things differently today than we would have a year or 2 years ago.
The question that comes to my mind is I don't remember you
having a positive suggestion of what we should do at this point in
time. You were very articulate in pointing out the problems of our
country and outlining the extent of these problems, but I don't remember any positive, constructive suggestions.
Mr. WRIGHT. Would you like for me to try to come forward with
some suggestions?
Mr. STANTON. In due time. You don't have to do it here today. I
think it is time that we would appreciate seriously suggestions
from all sides of the aisle, especially the leadership, about what we
could do.
Mr. WRIGHT. I think Congress does share a substantial part of
the blame because we have failed to fulfill our responsibilities in
curbing the Federal Reserve, and we have created conditions that
give excuse to the Federal Reserve and rationale to those who believe in high interest rates to maintain them at a high level.

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We have done that by setting in motion those factors which have
made absolutely inevitable the highest deficits in history.
Mr. Volcker, in his theorizing, relates interest rates to deficits. I
talked with him in 1980, after a group of us had sat down together
and laboriously, painfully, come to $21 billion in reductions in expenditures.
We talked to Mr. Volcker at the time and said if we put this in
effect after an around-the-clock session for about 10 days, presided
over by the then majority leader of the Senate, Mr. Byrd, and
myself, and participated in by all committee chairmen, we said Mr.
Volcker, if we put these into effect, will you then move with a
more accommodating monetary policy so that interest rates may
come down by 3 or 4 percentage points? He said yes, that is basically what we have in mind. This is what it is going to take. Well, we
did, and he did not.
I think we were trying to fulfill our responsibility at that time.
So what do we do now? What is causing the high interest rates?
Let's take the prevailing theory that they are caused by the prospective deficits. The deficit for fiscal year 1983 probably will not be
$91.5 billion, as originally advertised. Only last week before the
Budget Committee the Secretary of the Treasury, Mr. Regan, said
it would be quite substantially more than that because of this
sharp decline in the economy.
Probably now it is acknowledged in the administration that it
will be $120 billion, if we do everything just exactly as the President has asked us to do for fiscal year 1983, $120 billion. That comports rather roughly with the figures suggested by the Congressional Budget Office, which I think come out to like $126 billion.
All right, let's say that is a culprit, that big deficit and the probable deficit of $140 billion in 1984 and $150 billion in 1985. Therefore, let us examine what is causing the deficits.
Why so suddenly do we have these bigger than ever deficits
looming ahead of us, in spite of having reduced domestic expenditures by about $40 billion last year? What is different that makes
these deficits loom so large?
Well, the first thing that comes to mind, of course, is that monumental tax cut, the biggest tax cut in history; $96 billion of the
1983 fiscal deficit is going to result directly from the tax cut that
we voted last year.
We bled the Treasury of some $96 billion. Some of that may have
been good, you know. I think there were some good ideas in the tax
cut, the idea of trying to encourage people to invest in those specific things that would improve our productivity and make American
products more competitive. That was good.
There were some other things that were good. I don't want to
blame it as a whole, but it was excessive. I think all of the economists—conservative, liberal, and moderate alike—tell us that the
tax cut last year was grossly excessive, adding some $96 billion to
the deficit in 1983.
If you abolish the tax cut, you could nearly abolish that deficit in
one fell swoop. But of course that is not likely to be done.
Let's look at it frankly. You say this is our responsibility
Mr. STANTON. Excuse me for interrupting, but that is the kind of
answer that I expected and I wanted. This is a good dialog, but the

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difficulty of the Congress is that we got into a bidding war on the
taxes. The difference between the Democratic proposal and the Republican bill that passed was very small at the time all of the bidding on the tax bill took place.
So, fairly and realistically the leadership on both sides and the
Members, including ourselves, are to blame that we did not get together with a tax bill. I am certainly not blaming the Democratic
Party for that.
Mr. WRIGHT. I am not blaming the Republican Party per se.
Mr. STANTON. We should learn from that, though, that we had
no alternative. Both of them went too far.
Mr. WRIGHT. I think that is true. I would agree with you. The
bidding war was very unproductive, counterproductive, and what
we did as a Congress, I think, set in motion inexorable forces that
make that budget deficit loom so large.
As a matter of fact, I did go see the President one day, at his
invitation, the Speaker, Chairman Rostenkowski, and I. We went to
visit with him and Senator Byrd and some of the Republican leaders of the House and of the Senate at his invitation, ostensibly, to
see if there were some way in which we could find some compromise on the tax cut.
I took a piece of paper with me which represented a suggestion
that I had, conceptual. It would have had instead of a 5-10-10 a 55-5 individual tax cut, and it would have tilted it a little bit more
to the average income people instead of just, you know, the wealthier people.
I would have allowed certain things such as targeted tax breaks
for investments designed specifically to improve our industrial
plant machinery and a few of the other things that were included
in the President's bill, but the total tax loss, instead of being $280
billion over the next 3 years, would have been just about half of
that figure in the 3-year term. Instead of being $96 billion next
year it would have been in the nature of $45 billion next year.
That was scoffed at. The President took it and looked at it and
didn't say anything, but Mr. Regan and some of the others just said
that is no good, and I got the impression that our purpose in being
down there was not to see if there were some mutual place that we
could agree but rather to persuade us to compromise on what the
President's people had already decided.
That was the impression I got. In any event, it was unavailable,
it was not a successful endeavor. I think if someone—perhaps not I,
but someone else—had been able to prevail upon the powers that
be, both Democratic leaders in the House and the President, to
settle for a less ambitious, less costly tax cut last year, we would be
in an awful lot better position today and interest rates would be
lower.
Mr. STANTON. I appreciate your remarks, Jim. We could keep on
like this, but everybody would get mad at us.
Mr. WRIGHT. Those that aren't getting mad at me are getting
mad at you and vice versa.
The CHAIRMAN. That was a very good repartee. I would like to
mention to the members that we have the distinguished majority
leader with us, and in the wings we have waiting—and he has been
here about 15 minutes—the Secretary of the Treasury.

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So I would ask the members to take note of that as we go
through the question and answer period with our majority leader.
Mr. Gonzalez?
Mr. GONZALEZ. Thank you, Mr. Chairman. Thank you, Mr.
Leader.
I recall vividly the last visit you had under similar circumstances. I think it was last year or maybe it was the year before. I
need not belabor this except that though our distinguished ranking
minority leader brought up the fact that one of the things he admired was your nonpartisanship. But that is the issue.
He also said that there was very little difference between the Republicans and the Democrats in these great crises such as the tax
bill, which to me represents the most retrogressive, the biggest
giveaway of the Treasury since Andrew Mellon. If that is not partisan, I don't know what is. There were some of us that are Democrats that did everything we could and were belabored for being
partisan and being obstructionists.
I admired very much the presentation. Some of us have been like
coyotes out in the brush, braying to the moon, nobody listening
except those unfortunate people that have insomnia.
Mr. Leader, I think the distinguished ranking minority leader
here on this committee did make a point; that is, where do we go?
What are our marching orders? This is what the people are waiting
for, and they are there. They know the difference.
It is true interest rates is the big demon, but here we have been
told it is inflation. Now that inflation is down nobody in my district
that I have talked to, including my wife, would tell you that inflation has gone down. That grocery bill is bigger than ever and gets
less than ever.
So, the people aren't being fooled. I mean, we can kid ourselves
up here and we can have this camaraderie about being nonpartisan
and all of that, but we have to fight this. The big criticism is that
you all are like rapiers, really fine rapiers, but what we need is a
sledge hammer.
I don't know. You know, it is like my predecessor from this district, Maury Maverick, Sr. when he was assailed—and I was a student, but I remember it like it was today—because he was accused
by the then conservatives as being against the Constitution.
The Supreme Court was retooling most of the action that Congress was taking on an emergency basis. Old Maury said sure, I am
for the Constitution. I have gone to war on behalf of the Constitution. I have suffered wounds because of that war. Of course I am
for the Constitution.
But I am for the Constitution and groceries, too, and this is the
issue right now. Where do we go? What is our marching order? I
know that I just came across this here that this is what I think we
need and want, Democrats with guts. This is what we have desperately needed since last year.
What can we give as a marching order? I have been advocating
impeachment and everything I could come up with that I think the
Congress—the gentleman said a while ago, I almost thought I was
going to get an endorsement when you said there is nothing you
can do about Volcker. Of course you can. You made a pretty good
beginning case of impeachment this morning.

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I realize the reality of the situation, but what is our marching
order? The people want to know. What are we doing about it? We
know what the problem is. What do we do about it?
Mr. WRIGHT. Maury Maverick wrote a book which both of us
read at the University of Texas, "In Blood and Ink." Do you remember that book? I think some of the things I am ready to suggest to you might be the sort of thing that old Maury would have
appreciated.
In the first place, Mr. Volcker, the reason I said there isn't much
we can do about it is because I think he is appointed by the President and I would presume removable by the President.
When Lyndon Johnson was Vice President he told me something
I suppose all Presidents knew. He told me that Mr. Kennedy had a
policy in which whenever he appointed anybody to any administrative office he received from that person that day of his appointment an undated but signed letter of resignation. He put all of
these in a drawer. Then upon his determination—his, the President's—he could pull one out, date it, call in the press and say I am
so sorry to announce that today I have received a letter of resignation from this great American, which I accept with such reluctance.
I told that to Jimmy Carter after he had been President about 3
years and he never knew it. I feel bad I had not suggested it before.
I tried to get the word to President Reagan about that idea. I don't
know whether it registered. He is the guy that can remove
Volcker. He is the one who can remove Volcker.
Harry Truman, when he was President of the United States in
1951, I guess it was, the Federal Reserve Board increased the prime
rate from 5.5 to 6 percent. Whereupon Harry Truman, President of
the United States, called in members of the Federal Reserve Board
and said gentlemen, this won't do. The people cannot afford interest rates that high. You have to go back and disgorge. Whereupon
they did because Harry Truman was President of the United
States.
Andrew Jackson had a great battle with the Bank of the United
States to determine who was running the country. It emerged that
Andrew Jackson was President of the United States.
Now it seems to me when you get in a situation like that we here
sitting in the Congress, 435 of us in the House and 100 over in the
Senate, wise though they be, cannot fine-tune the interest rates.
You know, we cannot decide on a day-to-day basis, vote on what
the prime rate isf going to be. Somebody has to do it. That somebody has to be appointed by the President.
I think he has to be answerable to the President. I think the
President has to have the responsibility to move him if he isn't.
Second, what do we do about these deficits? What I am getting
ready to say doesn't represent the Democrats, just me. I will tell
you doggone well quick what I think I would do.
I know that we are not going to be able to reduce that deficit by
any appreciable amount unless we come to grips with what is causing the deficit, and that is the monstrous, monumental tax cut, the
biggest in history, $250 billion taken out of the Treasury in the
next 3 years.

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I surely would do away with the so-called safe harbor leasing
provision, which is encouraging the biggest companies in the country to buy and sell and barter and trade among one another in tax
avoidance schemes.
I think that is the first thing I would do away with.
I think it would be prudent if we were to look at that third year,
10-percent marginal rate cut. You know, it isn't a 10-percent cut in
taxes. That is where people were deceived, bless their hearts. They
heard that and they thought oh, good, I am going to have myself a
10-percent cut in the taxes I pay.
Well, that isn't true, of course. The average citizen, if he pays at
a 20-percent rate, got last year 5 percent—not 5 percent of his
taxes, but 5 percent of the 20 percent, which is 1 percent, not
enough to let him buy a car, not enough to let him buy anything
that would stimulate the economy. The average citizen got practically nothing.
As a result of that tax cut voted last year, the relative percent of
the tax burden in the income tax code, as borne by corporations
and by individuals, shifted dramatically.
Last year, 1981, corporations paid 28 percent of the income taxes
and individuals paid the remainder. That was down substantially
from 40 percent that corporations paid in 1960.
You know what they are paying this year? 14 percent. 14 percent
is one-half the amount—one-half the percent of the taxes paid
would be paid by corporations this year and that slack, of course, is
taken up by individuals who now are paying 86 percent of the
income tax.
Mr. GONZALEZ. Are they headed for zero?
Mr. WRIGHT. Of course they are headed for zero, if this thing continues as it is set to continue. You know, any corporation that pays
taxes, I think the executive officer of the corporation is probably
going to be in trouble with his board of directors for malfeasance.
Now, we have got to change that around if we are going to do
anything meaningful about balancing the budget. We can fiddle
around all we want to with all of these little old things.
You know one-third of the budget is entitlements. Now, I don't
want to cut the pay for the social security recipients for the retiree.
The guy who has given his life to serve the U.S. military, I don't
want to reduce his pay. That is about one-third of it.
Another one-third of it is military. As much as I am a defender
of and believe in a strong military establishment, I think one of the
things we can do is to hold back the rate of increase to the 7-percent real term increase that the President himself advocated last
year as a steady annualized proposition.
He said if we raise our military expenditures in real terms after
inflation by 7 percent a year, year after year, we will establish in
the minds of the world we mean business.
Last year we voted about a 9, 9.5-percent increase for this year.
This year he is asking for about a 13-percent increase. If you cut
some of that back, we can save some money.
I say those things and you ask what can we do. I think those are
a couple of things we can do to reduce the deficit. I have an idea
about how we can make it less profitable for people to charge high
interest, but it is so unorthodox, Henry, that I don't know whether

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even you would like it. If so, you would be about the only one, you
and I.
The CHAIRMAN. The time of the gentleman is expired.
Mr. STANTON. Mr. Chairman, I have never seen the majority
leader more eloquent than he is now or has been this morning. I
would call upon him for a little cooperation.
We do have a problem on the committee. We do have an opportunity to see the majority leader quite often and good colloquys take
place.
We do have this morning the Secretary of the Treasury, who has
come up. I promised him when he set it up at 10 or so that he
would be free at 12:30 for a very important meeting. I wonder if
somehow we couldn't get some kind of cooperation to get the majority leader back.
Mr. WRIGHT. I would be delighted to step aside and yield my
place to Secretary Regan, if that is the wish of the committee, because I know his time is valuable and I don't really have any
desire to usurp the time of the committee.
I would be glad to yield.
Mr. STANTON. We on this side would appreciate that deeply.
The CHAIRMAN. One moment, please. Let me ask the members on
this side if any of them have any burning questions that they
would like to propound to the majority leader at this point in time,
with the understanding that certainly you would be happy to
return in the near future?
Mr. WRIGHT. I appreciate that. Sure.
The CHAIRMAN. Mr. Leader, we thank you for your presentation
and cooperation, and I personally want to apologize to you and the
members for this conflict.
Mr. WRIGHT. It is not necessary at all. I am just honored to step
aside for such a distinguished American as Don Regan.
The CHAIRMAN. At this time we will ask the Secretary of the
Treasury, Donald Regan, to appear from the wings.
Good morning, Mr. Secretary. Welcome.
I would like to state for the record that indeed many members
on this side did have many questions of the majority leader. They
understand the time restraints and they relinquish and cooperate
with the chairman and Mr. Stanton, allowing the Secretary of the
Treasury to appear at this time.
Our second witness this morning is the administration's chief
economic spokesman, Secretary of the Treasury Donald Regan. We
have been very anxious to have you before us before we completed
our hearings and reported to the House on monetary policy. It is
essential that this committee should know how well the announced
policies of this administration mesh with the Federal Reserve's
monetary policy.
With all due respect to both you and Chairman Volcker, the
public, specifically the financial markets, have been bombarded
with conflicting signals about just how the Federal Reserve and the
administration horses are hitched to the Nation's economic wagon.
Over the past few weeks and months the romance has been off and
on. Perhaps only Liz Taylor and Richard Burton have had more instant reconciliations.

126

The Wall Street Journal for January 21 carries a big headline:
"Treasury Chief Steps Up Criticism of Fed, Urges Better Control
Over Money Supply/'
On January 28, the Washington Post: "Regan Blames Fed For Interest Rates—Urges Easier Money Policy/'
On January 30, the New York Times devotes 20 inches of type
under a headline: "Reagan vs. Fed: The Fallout/'
On February 1, the same New York Times comes back with a
new story with the headline: "Reagan Officials Praise Federal Reserve Moves/'
On February 3, the Wall Street Journal carries this reassuring
headline: "Treasury Chief Reiterates That The Economy Will Have
'Roaring' Recovery."
Ten days later the Washington Post splashes this headline across
its pages: "Volcker Points Again At Deficit, Economy Will Not
Come 'Roaring' Back, He Says."
And the Wall Street Journal: "Volcker Warns Of Collision In
Fiscal Policies. Deficits Pit Reagan Growth Plan Against Bid To
Curb Inflation, Fed Chief Says."
A few days later, on February 19, the front pages carried a new
message. The New York Times: "President Backs Federal Reserve
and Tight Money."
And the Washington Post: "President Offers to Cooperate with
Federal Reserve."
Five days later, the Washington Post: "Volcker Blasts Huge Deficit."
In his last press conference on February 19 President Reagan
stated: "I have confidence in the announced policies of the Federal
Reserve Board."
Mr. Secretary, may we judge from that statement and other related comments at that same press conference that the administration and the Federal Reserve are on the same wave length, that
the Federal Reserve's targets are your targets?
I think it is very important not only to this committee but to the
financial markets to know the present state of this ping pong
match. I must admit, Mr. Secretary, that I can well understand
why you and Mr. Volcker are so anxious to find someone else to
blame. The economy is a sorry mess and neither one of you really
wants to take credit.
Reaganomics has now been in place 434 days. More than 10 million Americans, who want jobs, are without work. Millions more,
discouraged by futile searches for jobs, are idle.
I might state the unemployment rate in Rhode Island, where
Succotash Point is located, as of Saturday is 10.3 percent. Thousands of American families, unable to afford 17 and 18 percent
mortgages, have seen the dream of home ownership fade.
Scores of small businesses, crushed by high interest rates and a
slumping economy, have padlocked their doors and others face certain bankruptcy in the coming months. Nearly one-third of the Nation's manufacturing capacity stands idle, producing neither jobs
nor goods.
This is the bleak picture as we emerge from the second winter of
the administration's grand experiment with supply side economics.
Through the months the administration's line remains the same:

127
"Wait, wait, wait, the miracle is coming somewhere, sometime and
somehow/' I am not sure it is getting through to the inner circles
of the administration, but the country is responding with a loud
"Enough, enough, enough/'
With all due respect to you, Secretary Regan, and the other economic architects of this administration, it is time perhaps to admit
failure. This has been a losing season. It is time for a new game
plan, as George Steinbrenner would say.
Supply side economics has come up with one product in abundance—uncertainty: uncertainty for the financial markets, uncertainty for workers trying to find jobs, uncertainty for small businessmen struggling to survive, uncertainty for nearly everyone in
this country.
Mr. Secretary, the March 22 edition of Business Week quotes
you: "* * * interest rates are performing an act of levitation that
we cannot explain believably." Yes, Mr. Secretary, we are all
having great difficulty "explaining believably" any part of the administration's program.
Mr. Secretary, we will put your entire statement in the record
and we will allow you to proceed. We want to thank you for your
patience with having a witness prior to you who was very eloquent
and stimulating.
STATEMENT OF HON. DONALD T. REGAN, SECRETARY OF THE
TREASURY
Secretary REGAN. Thank you, Mr. Chairman, and members of
the committee. It is a pleasure to be with you today to discuss the
economic outlook and the budget.
The economy continues in the grip of the second recession in 2
years. This latest downturn began in July of 1981, hard on the
heels of the sharp recession of 1980, from which the economy has
never really recovered. Together they form one long period of near
zero growth.
The causes of the problem are clear: years of excessive money
growth, rising inflation, rising interest rates, rising tax rates and
rising Federal spending as a share of GNP.
With the help of the Congress we hope to bring the Federal
spending and deficits under control. With the help of the Federal
Reserve we hope to bring inflation and interest rates down. These
steps will lead to an early end of the current downturn.
In spite of the continued slide in the first quarter of 1982, there
are some hopeful signs. Excessive inventories are being drawn
down at a rapid rate. This is typical of the last stages of a recession. Retail sales are rising, housing starts are up slightly, durable
good orders have leveled off and, very important to the financial
well-being of all Americans, whether of working age or retirees, inflation continues to fall.
More importantly, we have in place a sound, long run tax
system. It will not only help bring an early end to the current recession, but it will promote rapid growth of income, savings, investment, and employment for years to come.
That tax system, with a healthy economy, will generate as much
revenue as Government should reasonably be allowed to spend.

128

However, the short run revenue picture has been heavily affected
by two factors: the recession and the drop in inflation.
Nominal GNP is estimated to be 4 percent lower than the one
forecast last March; the 1982 unemployment rate, over ll/2 percentage points higher. These changes in the economic assumptions
have added roughly $60 billion to the deficit projections for fiscal
year 1983 compared to our estimate for last year. Higher interest
rates and a higher level of national debt by fiscal year 1983 have
added $30 million more.
We therefore have to face some tough decisions about how to finance the deficits until the growing economy triggered by our reformed tax system brings growing revenues into line with restrained outlays.
Some have urged us to revoke the incentive creating tax cuts already in place. The result would have been lower real growth for
many years into the future, a self-defeating major change in a permanent tax program to handle a temporary problem.
Instead, we shall propose certain worthwhile tax reforms, upgrade our tax collection program and renew our efforts at controlling spending.
Deficits must be reduced. They rob the private sector of financial
and real resources needed for growth and divert those resources to
government use. So do taxes.
The root of the problem is the Federal spending, which appropriates those real resources and then must find the means to pay for
them in one way or another. The budget deficit can and must be
narrowed, primarily from the spending side.
Insofar as spending is not reduced, it is preferable to close the
remaining transitional recession deficits by borrowing rather than
by taxes. The funds are pulled from the private sector in either
case, but taxes impose a larger cost in terms of reduced incentives
for real growth and would choke our future expansion.
The budget deficits can be handled in a nondisruptive fashion.
The first three charts in my prepared testimony help to put the
deficit in a perspective. As can be seen, the projected deficits,
though some of them are of record dollar levels, are not unusual
following a recession when measured as a percent of gross national
product.
There has been considerable concern that our projected deficits
will drive up interest rates. However, we believe there will be
ample private sector savings to finance these deficits and permit
strong increases in capital formation.
There will be no need for inflationary money creation by the
Federal Reserve, which would indeed drive up interest rates. Compared to 1981, private savings will be more than $60 billion higher
in 1982, more than $170 billion higher in 1983 and more than $260
billion higher in 1984.
Lack of growth has been responsible for much of the current and
projected deficit. As a rough rule of thumb, each time growth falls
off by enough to produce a 1-percent increase in unemployment,
the budget deficit widens by more than $25 billion. In fact, if we
had grown fast enough over the past 4 years to get unemployment
down below 6 percent, the current deficit would be roughly $75 billion lower.

129

Growth is the only way to balance the budget while promoting
rising real income and employment. I would like to point out very
firmly that any changes in the economic recovery program which
reduce real growth will tend to worsen the budget picture. Changes
which reduce individual or business savings by as much or more
than the deficit will only worsen the situation in the credit markets.
The budget is not merely an accounting document. There are behavior changes and economic repercussions from tax and spending
shifts which affect savings, investment, labor supply, income and
revenue.
The facts should be kept clearly in mind as we look at the deficits in this budget.
TAXATION SPENDING IN THE BUDGET

The Tax Code we have in place plus the tax proposals contained
in the administration's budget regarding obsolete provisions and
improved tax compliance measures will generate as much revenue
in the long term as the Government should be allowed to spend.
We project long-term receipts between 19 and 19.5 percent of
gross national product between 1983 and 1985, under our proposals.
These percentages would rise slowly thereafter with real economic
growth and scheduled payroll tax increases.
This compares with 18.7 percent from 1964 through 1974; 19 percent from 1975 through 1979. Receipts were 20.1 percent and 21
percent of gross national product in 1980 and 1981, and they will
be approximately 20.3 percent in 1982. Receipts, therefore, will be
in line with or even higher than historical levels.
On the other hand, spending on- and off-budget is already too
high and threatens to go higher. It was 23 percent and 23.7 percent
of GNP in 1980-81 and will exceed 24 percent of gross national
product in 1982. This compares to 19.8 percent from 1964 through
1974 and 22.1 percent from 1975 through 1979.
We have recommended a decline to just over 21 percent of gross
national product by 1985 and further declines thereafter.
There is a general perception that spending and taxes have been
slashed. In fact, all we have done so far is to reduce the rate of
growth in spending, and we have just begun to see a modest tax
reduction.
The personal tax rate reductions of the ERTA are not substantially larger between 1981 and 1984 than the continuing bracket
creep and the payroll tax increase of 1981-82. In fact, there was a
net personal tax increase of roughly $15 billion in 1981.
In 1982 taxpayers will just about barely break even. Not until
1983 and 1984 will there be real cuts for most families, totaling $12
to $15 billion each year. Taxes will rise again in 1985 due to a
scheduled payroll tax increase.
On the other hand, even under our proposed spending restraint,
spending will remain well above long-term averages for several
years to come. If major budget changes are to be made, they should
be made in spending levels, not taxes.

130
THE IMPORTANCE OF A STABLE TAX POLICY

It is unlikely in the extreme that tax increases could succeed in
balancing the budget. First, they would weaken the economy and
would be partially offset by slower growth. Second, they would encourage higher spending. In spite of the fact that the tax receipts
of the Federal Government rose nearly $250 billion from fiscal year
1977 through fiscal year 1981, the Government ran deficits of
nearly $200 billion.
BUSINESS TAXES

Stability in tax policy is essential for private sector planning and
economic recovery. Millions of firms planning billions of dollars of
investment decisions now must be in a situation of great uncertainty with respect to leasing, ACRS and other provisions.
The decisions of the Congress regarding ACRS and related provisions have the power to unleash a flood of investment or to choke
off tens of billions of dollars of spending on modernization and expansion of plant and equipment. Until the political decisions are
made, the economic decisions and the economic recovery are on
hold.
TAXES ON SAVING

Consider the impact on personal saving of a decision to suspend
the third year of tax cuts and indexing. Over the life of a 10-year
bond purchased in 1983, the higher and rising tax rates would
reduce the rate of return on that bond from between 1 and 2 percent to about zero after taxes and after inflation. This would discourage savings by $25 to $50 billion per year, with obvious adverse
consequences for interest rates, investment and real growth.
TAXES ON LABOR AND SMALL BUSINESS

There are those who would preserve the business portions of the
ERTA and cancel most of the remaining individual tax rate reductions. Such a move would be extremely counterproductive to business, as well as to individuals.
In my years at Merrill Lynch I came to appreciate the importance of the individual and his or her role as a saver, an investor,
an entrepreneur. I am surprised that others in commerce or industry do not appreciate the importance of the individual in the roles
of employee and customer.
Those who think a business is only in terms of large corporations, forget the millions of partnerships, proprietorships and subchapter S corporations run by entrepreneurs whose profits are
taxed at the individual level, at individual tax rates.
As for employees and consumers, consider the effects of suspending the third year of the tax cut and indexing on the cost of labor
and the standard of living of the American family.
It may come as a surprise to some, but labor is a far larger factor
of production than capital. Labor is between two-thirds and threequarters of the total cost of inputs in most years for most products
and industries.

131

Labor inputs outweigh capital inputs 2 or 3 to 1. It is time to remember that taxes on labor and the resulting higher labor costs
are extremely damaging to American business.
Tax rates on labor at the Federal, State and local level have
risen until it now costs a firm more than $1.70 to compensate a
worker for a $1 increase in the cost of living. Without indexing, it
would cost $2.50 or more in the 1990's.
Any wage increase, whether merely COLAs or a real wage hike,
would send taxes rising and tend to push labor costs up faster than
the prices the firm receives for its products. The likely consequence
of such a tax situation would be falling profits, falling employment
and falling after-tax wages.
Labor would absorb substantial portions of the rising tax burden,
amounting to several hundred dollars in higher taxes by 1986. This
is only the direct cost.
The weaker economy, reduced savings, investment and growth,
lower productivity and reduced competitive position of American
labor in the world economy would lower the market wage itself, reducing the family's real earnings by hundreds of dollars more.
American workers and savers are the primary customers of
American business. There is no way such an impact on the real
income of its customers would be good for business.
THE IMPORTANCE OF A STABLE MONETARY POLICY

The President's original economic program included the recommendation that money growth be gradually reduced to a noninflationary pace. During the past year the Federal Reserve made significant progress toward that goal, although somewhat faster at
first and more erratically than we had antcipated.
Recognizing the short-run costs and the long-run benefits of controlling inflation, the administration remains committed to its goal
of slow and steady growth in the money supply over the long run.
Given that goal, we supported money growth in the middle of the
Federal Reserve's Ml-B target range in 1981, and we support
money growth in the upper third of the Federal Reserve's tentative
M-l target range for 1982.
Currently M-l is about $4 billion above the upper bound of the
1982 target range due to an unexpected bulge in money growth in
January. This was partially wound down in February.
We are confident the Fed can and will meet its targets for the
year while allowing relatively modest but steady expansion of M-l
from here on.
There are those who are urging the Federal Reserve to abandon
its goal of a steady and moderate growth in the money supply.
They believe faster money growth would depress interest rates.
History does not support that view, as the attached charts show
very plainly.
For many years it has been apparent that inflation is the main
factor determining the level of interest rates. Excessively rapid
money growth in the past has brought about the current high
levels of interest rates.
The evidence is very clear, faster growth of the monetary base
produces faster growth of M-l and is associated with rising interest

132

rates. Slower growth of the monetary base in M-l leads to falling
interest rates. Volatility in the growth of the money supply also
adds to interest rates by adding to uncertainty and risk.
The administration strongly supports the Federal Reserve's announced goal of a steady and moderate growth of the money
supply, not because we seek to drive interest rates up, but because
it is the only way to bring inflation and interest rates down on a
permanent basis.
Mr. Chairman, I would be pleased to answer any questions you
might have.
[The prepared statement of Secretary Regan follows:]

133
TESTIMONY OF THE HONORABLE DONALD T. REGAN
SECRETARY OF THE TREASURY
BEFORE THE
HOUSE BANKING COMMITTEE
Mr. Chairman and Members of the Committee,
It is a pleasure to be with you today to discuss the
economic outlook and the Budget. I hope this occasion will
be part of an on-going dialogue between the Committee and
the Administration over the need to restore a stable fiscal
climate to promote long-term noninflationary growth in the
American economy.
As you know, the economy continues in the grip of the
second recession in two years. This latest downturn began
in July 1981, hard on the heels of the sharp recession of
1980, from which the economy had never really recovered.
Together they form one long period of near zero growth.
The causes of the problem are clear: years of excessive
money growth, rising inflation, rising interest rates, rising
tax rates, and rising Federal spending as a share of GNP.
With the help of this Committee, we hope to continue the
fight to bring Federal spending and deficits under control.
With the help of the Federal Reserve, we hope to bring inflation
and interest rates down. These steps will lead to an early end
to the current downturn.
In spite of the continued slide in the first quarter of
1982, there are some hopeful signs. Excess inventories are
being drawn down at a rapid rate. This is typical of the last
stages of a recession. Retail sales are rising. Housing starts
are up slightly. Durable goods orders have leveled off. And,
very important for the financial well-being of all Americans,
whether of working age or retirees, inflation continues to fall.
More importantly, we have in place a sound long-run tax
system for the 1980's. It will not only help bring an early
end to the current recession, but will promote rapid growth of
income, savings, investment and employment for years to come.
That tax system, with a healthy economy, will generate as much
revenue as government should reasonably be allowed to spend.

134
However, the short-run revenue picture has been heavily
affected by two factors: the recession and the drop in
inflation — one bitter pill and one piece of candy which
together have significantly decreased revenue to the point
of causing large deficits. The recession is temporary, and
the decline in inflation is most welcome.
Nonetheless, nominal GNP is estimated to be 4 percent
lower than was forecast last March, and the 1982 unemployment
rate over one and one-half percentage points higher. These
changes in economic assumptions have added roughly $60 billion
to the deficit projections for FY-1983 compared to our estimate
last year. Higher interest rates and a higher level of national
debt by FY-1983 have added $30 billion more.
We, therefore, had to face some tough decisions about how
to cover the costs of some very important government programs —
how to make up the difference between the $666.1 billion in
revenues and the $757.6 billion in outlays — until the growing
economy triggered by our reformed tax system brings growing
revenues into line with restrained outlays.
Some have urged us to revoke the incentive-creating tax
cuts already in place. The result would have been lower real
growth for many years into the future. It would have involved
a self-defeating major change in a permanent tax program to
handle a temporary problem. Instead, we shall propose certain
worthwhile tax reforms, upgrade our tax collection program,
renew our efforts at controlling spending, and borrow to cover
the remaining deficit.
Deficits are not good. They rob the private sector of
financial and real resources needed for growth, and divert
those resources into government consumption. So do taxes.
The root of the problem is the Federal spending which
appropriates those real resources and then must find the
means to pay for them in one way or another.
The budget deficit can and must be narrowed from the
spending side. For too long, spending has been rising faster
than the economy has grown. The economy can no longer support
the burden. Some progress was made last year in reducing the
runaway rate of growth in Federal non-defense spending* Further
efforts will be required this year and into the future.
Insofar as spending is not reduced, it is preferable to
close the remaining transitional recession deficits of the
sort now being experienced by borrowing rather than by taxing.
The funds are pulled from the private sector in either case,
but taxes impose a larger cost in terms of reduced incentives
for real growth.

135
Borrowing diverts a portion of private savings away from
capital formation to enable the government to gain command over
a portion of current output. Taxing also enables the government
to have at its disposal a portion of current output. Taxation
reduces private saving and it too cuts back the resources
available for capital formation.
However, there is a difference. In recent years, tax
increases have generally taken the form of allowing inflation
to push taxpayers into higher brackets, or allowing inflation
to erode the value of depreciation allowances. The former
reduces the value of incremental present or future wages and
interest income; the latter reduces the rate of return on
plant and equipment. The effect is to reduce the supply of
labor, savings, plant and equipment, cutting down on future
output. Thus, taxation often produces disincentives which
adversely affect future output, as well as directing a portion
of current output to the government.
Federal borrowing creates debt that must be serviced, and
this implies the future payment of taxes, but it need not
require an increase in marginal tax rates, as long as economic
growth produces an enlarged tax base. Thus, borrowing should
have less adverse impact on future output than taxation.
Therefore, in deciding how to cover the transitional deficits
associated with the current recession, we feel it is better to
borrow, while leaving the tax incentives in place for long-run
growth, rather than to undo the structural tax reforms of the
ERTA, and choke off future expansion.
We must continue to strive to reduce the deficit by
curtailing spending and promoting real growth. The budget
we are proposing take major steps toward closing that deficit
over the next several years. In the interim, it can be
handled in a nondisruptive fashion. The first three charts
help to put the deficit into perspective.
The projected deficits, though some of them are at record
dollar levels, are not unusual following a recession when
measured as a percent of GNP. On- and off-budget deficits
were 3.6 and 4.5 percent of GNP in Fiscal Years 1975 and 1976,
due largely to the 1974-1975 recession. Deficits are projected
to be 3.8 percent and 3.1 percent of GNP in Fiscal Years 1982
and 1983, largely as a result of the current recession.
There has been considerable concern that our projected
deficits will drive up interest rates. However, we believe
there will be ample private sector saving to finance these

136
deficits and strong increases in capital formation. There
will be no need for inflationary money creation by the Federal
Reserve, which would indeed drive up interest rates.
The deficits will be manageable because of the growth
of private sector saving. Private saving resulting from
normal year-over-year growth and the Economic Recovery Tax
Act will be several times greater than the total borrowing
requirement of the Federal Government in 1983 and 1984 and
thereafter.
The annual additions to total private saving are larger
than the rise in the deficit. They will produce "crowding
in" rather than "crowding out." This extra shot in the arm
of capital markets will put downward pressure on interest
rates. Even after financing the Federal deficit, there will
be billions of additional dollars each year for private
investment.
Normal year-to-year increases in saving exceed $40 billion
each year. This will be supplemented by the additional personal
savings and additional business retained earning induced by the
tax cuts. Compared to 1981, private saving will be more than
$60 billion higher in 1982, more than $170 billion higher in
1983, and more than $260 billion higher in 1984. Private saving
was $480 billion in 1981. It is projected to rise to more than
$740 billion in 1984.
Unfortunately, not all of this saving is available for
growth and financing deficits. Some is needed to replace wornout equipment. Net saving, which is gross saving less depreciation, is being diverted to finance government spending at an
alarming rate, although not so severely as in the recession of
1974-1975 (see appendix). Fortunately, net saving will rise with
gross saving. Nonetheless, every effort should be made to restrain
Federal spending to promote future investment and growth.
It has been lack of growth, more than anything else, that
has been responsible for the current and projected deficit.
As a rough rule of thumb, each time growth falls off by enough
to produce a 1 percent increase in unemployment, the budget
deficit widens by more than $25 billion. In fact, if we had
grown fast enough over the past four years to get unemployment
down below 6 percent, the current deficit would be roughly
$75 billion lower.
Growth is the only way to balance the budget while
promoting rising real income and employment. I would like to
point out, very firmly, that any changes in the economic
recovery program which reduce real growth will tend to worsen
the budget picture. Changes which reduce individual or business
saving by as much as or more than the deficit will only worsen
the situation in the credit markets.

137
it in column B. There are behavior changes and economic
repercussions from tax and spending shifts which affect
saving, investment, labor supply, income and revenue. Very
often, changes which may look good on paper will buy little
or no progress toward solving a budget problem, especially
compared to the economic cost to the whole nation of the
policy shift.
These facts should be kept clearly in mind as we look at
the deficits in this budget.
Taxation, Spending and the Budget
The tax code we have in place, plus the tax proposals
contained in the Administration's budget regarding obsolete
provisions and improved tax compliance measures, will generate
as much revenue over the long term as the government should
reasonably be allowed to spend. We project long-term receipts
of between 19 and 19-1/2 percent of GNP between 1983 and 1985
under our proposals. These percentages would rise slowly thereafter with real economic growth and scheduled payroll tax
increases. This compares with 18.7 percent from 1964 through
1974 and 19.0 percent from 1975 through 1979. Receipts were
20.1 and 21.0 percent of GNP in 1980 and 1981, respectively,
and will be approximately 20.3 percent in 1982. Receipts,
therefore, will be in line with, or even higher than historical
levels.
On the other hand, spending, on- and off-budget, is already
too high and threatening to go higher. It was 23.0 and 23.7
percent of GNP in 1980 and 1981, respectively, and will exceed
24 percent of GNP in 1982. This compares to 19.8 percent from
1964 through 1974 and 22.1 from 1975 through 1979. We have
recommended a decline to just over 21 percent of GNP by 1985,
and further declines thereafter.
There is a general perception that spending and taxes
have been slashed. In fact, all we have done so far is to
reduce the rate of growth of spending, and we have just begun
to see a modest tax reduction.
The personal tax rate reductions in the ERTA are not
substantially larger between 1981 and 1984 than the continuing
bracket creep and the payroll tax increases of 1981 and 1982.
In fact, there was a net personal tax increase of roughly
$15 billion in 1981. In 1982, taxpayers will barely break
even. Not until 1983 and 1984 will there be real tax cuts
for most families, totalling $12 to $15 billion each year.
Taxes will rise again in 1985 due to a scheduled payroll
tax increase.

138
On the other hand, even under our proposed spending
restraint, spending will remain well above long-term averages
for several years to come. If major budget changes are to be
made, they should be in spending levels, not taxes.
Importance of a Stable Tax Policy
It is unlikely in the extreme that tax increases could
succeed in balancing the budget. First, they would weaken
the economy, and be partially offset by slower growth.
Second, they would encourage higher government spending. In
spite of the fact that the tax receipts of the Federal Government rose nearly $250 billion from FY-1977 to FY-1981, the
government ran deficits of nearly $200 billion.
Consequently, the Administration hopes to balance the
budget by restraining spending and encouraging growth through
a stable incentive-creating tax program.
Business Taxes
Stability in tax policy is essential for private sector
planning and economic recovery. Consider the impact of sudden
changes in the tax law on the cost of plant and equipment and
the related investment decisions.
Millions of firms planning billions of dollars of investment decisions must be in a situation of great uncertainty with
respect to leasing, ACRS and other provisions. There is no way
for a firm to determine whether an investment is practical or
not until the tax picture is clarified. The decisions of the
Congress regarding ACRS and related provisions have the power
to unleash a flood of investment or to choke off tens of billions
of dollars of spending on modernization and expansion of plant
and equipment.. Until the political decisions are made, the
economic decisions, and the economic recovery, are on hold. The
right decisions will start the economy climbing. The wrong ones
will set it tumbling.
Taxes on Saving
Consider the impact on personal saving of a decision to
suspend the third year of the tax cut and indexing. Under
current law, over the life of a 10-year bond purchased in 1983,
a taxpayer who will be in the 33 percent bracket following the
third year of the tax cut would pay roughly one-third of his
interest to the government. But without the third year and
indexing, that tax rate would start at 39 percent and rise
within a decade to 44 percent and 49 percent, as the taxpayer's
income rises through the tax brackets with inflation. The
average of these tax rates would probably be nearly 44 percent

139
At a 10 percent nominal interest rate and 5 percent or
6 percent inflation, this rise in the tax rate would be enough
to cut a 2 percent real after-tax interest rate in half, or a
1 percent real after-tax interest rate to zero. Historically,
such swings in the real after-tax interest rate have shifted
the personal savings rate by one or even two percentage points.
This would be enough to remove $25 to $50 billion dollars per
year from the credit markets over the next decade, with obvious
adverse consequences for interest rates, investment, and real
growth.
Furthermore, the potential saver would know as soon as
these provisions were repealed what the impact would be on
the rate of return to saving. He would react at once, before
the bond were purchased, not 5 or 10 years later after having
committed money in good faith.
Taxes on Labor and Small Business
There are those who would preserve the business portions
of the ERTA, and cancel most of the remaining individual tax
rate reductions. Such a move would be extremely counterproductive to business as well as to individuals. I am frankly
amazed at the lack of thought behind such proposals.
In my years at Merrill Lynch, I came to appreciate the
importance of the individual in his or her role as saver,
investor and entrepreneur. I am surprised that others in
commerce or industry do not appreciate the importance of the
individual in the roles of employee and customer.
Those who think of business only in terms of large corporations forget the millions of partnerships, proprietorships
and sub-chapter S corporations whose profits are taxed at the
individual level at individual tax rates. The decisions of
these owner-investors and entrepreneurs are heavily influenced
by the personal rate reductions and estate and gift tax reforms
recently enacted.
As for employees and consumers, consider the effect of
suspending the third year of the tax cut and indexing on the
cost of labor and the standard of living of the American
family.
Total net output of goods and services in the economy
results from the combination of labor and capital. The value
added by these two factors of production is reflected in the
wages, salaries, rents, royalties, interest and dividends
they receive. Value added equals total national income and
total net output.
It may come as a surprise to some, but labor is far and
away the larger of the two factors. Value added by labor is

140
between two-thirds and three-quarters of the total in most
years for most products and industries. Labor inputs outweigh
capital inputs two or three to one. It is time to remember
that taxes on labor and the resulting higher labor costs are
extremely damaging to American business.
Over the last 15 years, inflation, bracket creep and
payroll tax hikes have sharply increased the pre-tax cost to
the firm of giving a worker a one dollar after-tax wage increase.
A median income worker now faces 40 percent to 44 percent
tax rates on added income. This is the sum of social security
and Federal marginal income tax rates, plus state and local
taxes at the margin. It is up sharply from the late 1960's,
when the marginal rates would have been roughly 26 percent
to 30 percent.
Consequently, it now costs a firm more than $1.70 to
compensate a worker for a $1.00 increase in the cost of living.
This is up from $1.40 in the late 1960's. Without indexing,
it will rise to $2.00 by the late 1980's, and to $2.50 or
higher in the 1990's. Any wage increase, whether merely COLA1s
or a real wage hike, would send taxes rising and tend to push
labor costs up faster than the prices the firm receives for
its products. Profits, employment, or real wages would tend
to fall continually over time in the absence of extraordinary
productivity increases. The competitive position of U.S. labor
in the world economy would suffer.
The likely consequence of such a tax situation will be
a falling after-tax wage. Labor will absorb a substantial
portion of the tax burden. The cost of eliminating the third
year of the tax cut and indexing to a wage earner making
$20,000 in 1982 and receiving a cost-of-living increase
thereafter would be substantial: $80 in 1983, $203 in 1984,
$289 in 1985, and $369 in 1986. This is only the direct cost.
The weaker economy, reduced saving, investment and growth,
lower productivity and reduced demand for American labor
would lower the market wage itself, reducing the family's
real earnings by two or three times the direct cost of the
higher taxes. American workers and savers are the primary
customers of American business. There is no way such an
impact on the real income of its customers would be good for
business.
Regulatory Reform
My emphasis on the importance of the structural reforms of our tax system is consistent with this Administration's general regulatory reform program, the goals of
which are also to promote savings and investment and to
reduce the costs of government regulation for all sectors
of the economy. The Administration's efforts are nowhere

141
more clear than with regard to the financial system, where
in past years an outdated regulatory system has caused the
redistribution of funds out of depository institutions to
institutions offering new financial products and services.
Thus, to assist our troubled thrift industry, the Administration has supported legislation to remove or lessen
restrictions which prohibit thrift institutions from exercising broader lending powers and would permit, through
separate subsidiaries, banks to compete in certain securities
activities. Further, as a member of the Depository Institutions
Deregulation Committee, I have been involved in the process of
removing interest rate limitations on depository institutions
so that they can compete equally to obtain funds with which
to support their vital lending functions.
In addressing the earnings losses of thrift institutions,
a variety of programs have been proposed which would involve
costly temporary infusions which would increase the Federal
budget deficit. We believe that Federal regulators now have
the necessary powers to assist troubled institutions and that
subsidy programs are not necessary. We have focussed on
structural changes to give the industry the ability to be
healthy in changing economic circumstances.
Importance of a Stable Monetary Policy
The President's original economic program included the
recommendation that money growth be gradually reduced to a noninflationary pace. During the past year, the Federal Reserve
made significant progress toward that goal.
Fourth quarter to fourth quarter, M1B grew by 5 percent
in 1981. December to December, the rate was 6.4 percent due
to rapid money growth at year's end. Compared to the inflationary rates of monetary expansion in the past — 7.3 percent
in 1980 and an annual average of 8.0 percent in the preceding
three years — this is a substantial deceleration in money
growth. The Federal Reserve's tentative target ranges for
1982, 2-1/2 to 5-1/2 percent for Ml, represent continued
progress toward noninflationary money growth and the Administration fully supports that general policy.
The Administration's original recommendation was that the
rate of money growth gradually be cut in half by 1984 from the
average 7.8 percent rate of the prior four years; this is the
assumption that we built into our economic projections. The
deceleration that has actually occurred was initially much
more rapid — almost three-fourths of the planned reduction
in the first year — until end-of-year increases in money
growth rates raised the level of M1B above the lower end of
last year's target range.

142
This more rapid deceleration of money growth has economic
consequences — some good, some bad. It is leading to a faster
reduction in inflation, but it also means reductions in real
output, employment, and real income. Lower inflation and lower
real output mean lower GNP and lower Federal tax revenues.
Lower inflation also means lower Federal outlays on indexed
programs; but only with a considerable time lag. In the interim,
the deficit widens. It is amply clear from history, both here
and abroad, that deficits, if not monetized, do not produce
inflation. Indeed, the lower rate of inflation is a partial
cause of the current deficit.
Recognizing the short-run costs and the long-run benefits
of controlling inflation, the Administration remains committed
to its goal of slow and steady money growth over the long run.
Given that goal, we supported money growth in the middle of
the Federal Reserve's M1B target range in 1981, and we support
money growth in the upper third of the Federal Reserve's
tentative Ml target range for 1982.
There are those who are urging the Federal Reserve to
abandon its goal of a steady and moderate growth rate of the
money supply. They believe that faster money growth would
depress interest rates. History does not support that view,
as the attached charts show.
For many years, it has been apparent that inflation is
the main factor determining the level of interest rates.
Excessively rapid money growth in the past has brought about
the current high levels of interest rates. As inflation has
risen or fallen in the past, interest rates haved moved in
step.
In the last year or two, however, interest rates have
risen relative to the inflation rate. This may be due, in
part, to the unusual volatility of money growth rates since
1980.
In the last two months of 1980, Ml fell at an annual rate
of 1.4 percent per year, after a sharp rise in the previous
five months. All of the growth in Ml in 1981 occurred in the
first four months of the year, when it grew at a 14.2 percent
annual rate, and the last two months of the year, when Ml
growth was at a 11.6 percent rate. In the interim, Ml was
fairly flat. In the six months from April to October, the
net change was a decrease of 0.2 percent, annual rate.
Early 1982 saw a very rapid increase in the money supply
through January, followed by a levelling off in February.
Currently, the level of Ml is $4 billion above the target
range for 1982. The rapid growth of money from November

143
through January was accompanied by rising interest rates,
reversing the dramatic decline in interest rates that had
been under way since September.
The evidence of the past two years is very clear:
e

Volatile money growth undermines the credibility of
long-run monetary controls, adds to uncertainty and
risk, and thereby helps keep interest rates high as
lenders seek to protect their principal.

Faster growth of the monetary base produces faster
growth of Ml and is associated with rising interest
rates. Slower growth of the monetary base leads to
slower money growth and falling interest rates.

The Administration strongly supports the Federal Reserve's
announced goal of a steady and moderate rate of growth of the
money supply, not because we seek to drive interest rates up,
but because it is the only way to bring inflation and interest
rates down on a permanent basis.
It is easy to illustrate why the financial markets watch
the money supply so closely, and why variability of inflation
and interest rates creates turmoil and uncertainty in the
bond markets. Old securities must fall in price to remain
competitive with new issues as interest rates rise. Conversely,
bond prices rise when interest rates fall. Consider the
history of the Treasury's 6-3/4 percent 20-year bond issued
on October 1, 1973, priced at $99.50 per $100 of face value
to yield 6.79 percent. Its value over time has fluctuated
substantially with market interest rates:

9/30/74
9/30/75
9/30/76
9/30/77
9/30/78
9/30/79
9/30/80
9/30/81
latest

Price

Yield to Maturity

84.63
85.69
92.19
95.44
86.06
80.19
69.69
55.75
62.50

8.41
8.32
7.59
7.25
8.44
9.38
11.37
14.96
13.38

As interest rates and bond prices have become increasingly
unstable in recent years, the risk involved in buying bonds
has increased. This has resulted in greater reluctance to buy
bonds on the part of those who cannot afford a risky porfolio,
and the emergence of a risk or volatility premium which has
driven interest rates higher than normal relative to inflation
in recent years. This is why stability in the rate of money
growth and interest rates is critical to the success of our
program.

144
APPENDIX
Full Employment Deficit
One way to illustrate the impact of the back-to-back
recessions of 1980 and 1981-1982 on the budget deficit is to
examine the high employment budget deficit. This concept
has been used in the past to measure the "stimulus" of budget
policy, -on the theory that deficits increase total spending
and pump up "demand". We reject the notion that deficits per
se are inherently stimulative. They must be financed by
borrowing in the absence of inflationary monetary creation.
Nonetheless, the one useful insight the high employment budget
does provide is a measure of the fundamental relationship
between the current policy level of spending and the current
tax code's capacity to generate revenue with the distorting
effects of the recession removed.
The high employment budget estimates the budget aggregates
that would result if the economy were continuously operating
at a high level of employment under the tax and spending
proposals contained in the FY-1983 Budget documents. The
unemployment rate at high employment is traditionally estimated
for this purpose to be about 5.0 percent. (However, many
observers feel the real economy has a long-term basic unemployment rate somewhat higher.) Potential real GNP is assumed
to grow 3.2 percent annually. (We believe this potential
growth rate can be increased by proper policies, but have
conformed to convention to provide estimates consistent
with those of earlier years.)
The CEA has estimated the high employment deficit through
FY-1985 on a unified budget basis. (The high employment deficit
can be computed on a national income accounts (NIA) basis or on
a unified budget basis. The major differences are the inclusion
of offsetting receipts from oil and mineral leases and asset
sales and the netting out of Federal retirement receipts and
outlays in the unified budget.) The figures are available
through FY-1985:

Receipts
Outlays
Deficit (-)

FY 81

FY 82

FY 83

FY 84

FY 85

636
644

691
702

723
739

768
793

830
860

-8

-11

-16

-25

-30

It is clear from the tables that the major portion of the
projected deficits of nearly $100 billion in FY-1982 and FY-1983
is due to the fact that the economy is operating at less than
full employment. The phased tax reductions result in small
year-to-year increments in the high employment deficit, and,
even in "demand" terms, cannot be regarded as large or excessively
stimulative. The bulk of the deficit increase, from $11 to $25
billion, is completed by FY-1984. By FY-1985, high employment
receipts~grow 8.1 percent over FY-1984, nearly matching the growth
of outlays at 8.4 percent.

145
Savings Flows and How They Fit into the Scenario
The following outlines some of the concepts underlying the
gross and net private savings figures commonly cited and provides
background on the savings numbers consistent with the economic
scenario underlying the budget. By whatever savings measure one
prefers, projected deficits as a share of savings are less than
in the 1974-1975 recession and the subsequent recovery, and are
declining.

In the National Income and Product Accounts (NIPA), gross
private saving is the sum of:
—

Personal saving — the difference between after-tax
personalincome of the household sector and outlays of
that sector for consumer goods and services, interest
payments, etc.

—

Corporate saving, consisting of depreciation allowances
plus undistributed after-tax profits. (This is equivalent to the cash flow available to corporations, both to
maintain and add to productive assets. Inventory profits
are excluded.)

•-

Depreciation allowances of the noncorporate sector
including unincorporated business enterprises plus
imputed depreciation on owner-occupied homes. The
latter, roughly $40 billion or about one-twelfth
of gross private saving, is the only item in the
saving figures which does not represent true cash
flow.

Gross private saving forms by far the larger part of total
ross saving. In addition to private saving, the total
ncludes the surplus of state and local governments (largely
the surplus of the pension funds for their employees, as
surpluses on operating account have been fairly narrow)
and the surplus or deficit of the Federal Government. The
latter is on a NIPA basis. In the next couple of years,
the NIPA deficit will be wider than the more widely cited
unified budget deficit (the difference arising from sales
of mineral rights and other transactions that are not
reflected in the NIPA but affect the unified budget).

Table 1 attached presents historical data on gross savings
flows as percentages of GNP.

146
Net private saving in the accounts is comprised of personal saving and the undistributed profits of corporate
business. (Profit-type income of unincorporated businesses
gets into personal saving.) Depreciation allowances are
not included in net saving. (The net saving figures are
close to, but do not quite represent available cash for
net "investment, as undistributed profits and returns to
unincorporated enterprises are after allowances have been
made for full replacement of inventories and fixed capital
used in the production process. They exclude inventory
profits, and depreciation is on a so-called economic
rather than book-basis, i.e., replacement rather than
historical cost.) Savings or dissavings of government
can be added to net private saving to get total net saving.
Net saving figures are commonly compared with net national
product (NNP, or GNP less depreciation allowances).
Thus, depreciation is excluded from both numerator and
denominator. Table 2 attached presents net savings flows
as percentages of NNP.
Domestic savings flows, either gross or net, may be
augmented by inflows from abroad, which are likely to
be attracted by the new tax climate.
In an accounting sense, total gross saving (including any
dissaving by the Federal Government) must match total
gross investment — the net additions to the stock of
plant, equipment, inventories, and residential structures
plus an amount sufficient to replace existing assets that
have worn out or become obsolete. In any year, investment
to replace existing assets far exceeds net additions to
the stock of productive assets. Similarly, total net
saving must equal net investment.
Gross Savings Flows in-the Scenario
Savings flows consistent with the economic scenario
underlying the 1983 Budget were worked up by the CEA. They
were, of course, forced to fit within the constraint of the
total uses of savings — overall investment response to the
rate of return changes in the ERTA plus Federal, state and
local deficits and foreign flows. The breakdown between
corporate and personal savings within the totals can be
affected by dividend payout assumptions, capital intensity
assumptions across corporate and non-corporate businesses,
etc. In keeping within the totals, personal savings rates
appear to have come out a bit low by historical standards.

147
The estimates yield substantial private savings flows,
although they do not appear to be out of line with the sum of
normal year-to-year growth, the business share of ERTA and
historical responses by individuals to tax reductions.
o

Historically, gross private saving has averaged about
16-1/2 percent of GNP. The peak ratio in the postwar
period was 18.2 percent in the recession year of 1975.
The next highest ratio was 17.5 percent in 1967. (See
left-hand column of table 1 attached.)
Gross Private Saving as a Percent of GNP
Budget scenario
1956-65
1966-75
1976-80
1981

16.3
16.6
16.7
16.4

1982
1983
1984

17.2 projected
18.5
19.1

The impact of ERTA on gross private saving can roughly
be estimated by calculating saving on the assumption
that the historic 16-1/2 percent share of GNP had been
maintained and comparing those numbers with the higher
saving flows projected in the new scenario. The implication of these calculations is that gross private saving in
the new scenario in 1985 is $101 billion more than if old
saving patterns prevail.
Gross Private Saving
Calendar
Year

1981 actual
1982 projected
1983
"
1984
"

Level
in
Budget

480
542
651
742

Level
Difference
at 16.5% from
of GNP
Budget
~ T 3 ~ ) ( 4 ) = (l)-(3)
billions of dollars

Yearly
Increase

62
109
91

521
581
641

21
70
101

Tax
Cut
ERTA
"T5T
)
58
115
151

Added
Savings as
% of ERTA
(6)=(4)/(5)
(percent)
36
61
67

148
In terns of total saving flows, including government
surplus, note that increased government deficits (dissaving)
resulting from a tax cut have no effect on total saving
if those tax cuts flow directly into increased private
saving, as the funds from ACRS, which are recorded as
retained earnings, might be expected to do. Of course,
private saving may increase by more or less than any tax
cut, depending on responses of households and businesses
to changes in after-tax real rates of return on prospective
investments. In the mid-19601s, personal savings increases,
partly as a result of above average income growth, exceeded
70 percent of the marginal tax rate reductions for three
years, rising to exceed the tax reductions in the fourth
year and thereafter. The personal savings rates in the
scenario assume a savings increase averaging roughly 45
percent of the personal tax cuts from 1982 to 1984.
Composition of Gross Private Saving in the Budget Scenario
o

The rise in business saving reflects:
1.

A recovery of the profit share (before allowance for
ACRS) and retention of a large portion of those
increased profits, rather than their distribution in
dividends.

',.

ACRS and other tax changes which reduce profits taxes
by about $10 billion in CY-1982, $19 billion in CY-1983,
and $27 billion in CY-1984.

The depreciation thrown off by a rising stock of capital.

The path of the personal saving rate is as follows:
Personal Saving Rate (%)
Budget scenario
1980
1981
1982
1983
1984

5.6
5.3
6.7
7.0
6.1

projected

The dip in 1984 was conditioned by overall constraints
imposed on the forecast, and appears to be an understatement. Personal saving available to households is related
to prospective real after-tax rates of return? these
should be vastly improved from returns available during
the 1970's, and higher in 1984 than in 1983. Personal
savings rates averaged 7.6 percent from 1965 to 1975.

149
Net Private Savings in the Scenario
Net saving figures indicate resources available to increase
the stock of productive capital after allowance has been made
for its maintenance.
o

As indicated by the figures in the left-hand columns of
table 2, ratios of total and net private saving to net
national product (NNP) were severely eroded in the late
1970's. In 1981, net private saving was 6.1 percent of
NNP compared with 8-3/4 percent during the late 1960's.
The scenario shows that late 1960's ratio being restored,
though not surpassed.

Net private saving
as percent of
NNP

Federal deficit
as percent of
net private
savings plus
S&L surplus

1956-65
1966-75

8.1
8.6

- 2.8
-14.5

1974
1975
1976
1977
1978
1979
1980
1981

7.6
8.9
7.7
7.3
6.9
6.7
6.2
6.1

-10.9
-53.8
-39.0
-30.0
-17.9
- 8.6
-35.0
-31.8

1982 projected
1983
1984

7.0
8.7
8.8

-45.0
-32.0
-28.0

The right-hand column of table 2 and the tabulation on
the prior page show the ratio of the NIPA Federal deficit
to the total net private savings plus supluses (if any) of
state and local governments. That ratio hit a peak of 54
percent in 1975. As indicated on the prior page, that
ratio in the scenario for 1982 never approaches the 1975
figure, and ratios for 1983 and 1984 stay below respective
figures for 1976 and 1977.
Gross private
saving as percent
of GNP
Administration
1981 actual
1982
1983
1984

16.4
17.2
18.5
19.1

DRI
16.3
16.7
17.7
18.4

Net private
saving as percent
Of NNP
Administration

DRI

6.1
7.0
8.7
8.8

6.0
5.8
7.0
7.6

150
GROSS SAVING AND INVESTMENT
LEVELS

Gross Private Saving
Personal
Business

1979

1980

1981

1982

1983

1984

400 .0
86 .2
313 .9

434 .1
101 .4
332 .7

478 .7
106 .6
372 .1

542 .0
150 .8
391 .3

650 .7
171 .7
479 .0

741 .8
163 .4
578 .4

16 .4
3 .6
12 .7

17 .2
4.8
12 .4

18 .5
4.9
13 .6

19 .1
4.2
14 .9

PERCENTS OF GNP
Gross Private Saving
Personal
Business

16 .6
3.6
13 .0

16 .5
3 .9
12 .7

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3.789
3^8*0
3.936
3.9*2
'.06*
3.82)
3.7*9
3.71)
3.5*8
3.'5*
3.36*
3.275
3.20*
3.250
3.238
3.325
3.*21
3.*73
3.*28

3.861
3.70)
3.8*1
3.933
'.070
'.257
'.233

TOTAL
con.

•.178
3.255
•1.302
2.7«'
1.83'
•1.087
•1.800
•1.o*8
0.786
1.231
0.208
•2.808
•0.32*
0.611
•0.811
-0.670
0.120
-0.356
0.076
-0.170
•1.781
•0.683
1.053
•1.065
-1.805
•0.281
0.500
-0.330
-*.110

-2.125
-0.056
-0.010
O.*04
•1.222
-0.859

rrwMt
5.7')
3.305
•1.021
3.21*
•1.07)
•1.929
•1.6*5
1.104
1.4)4
0.514
•2.28'
•0.23)
0.544
•0.7*1
•0.752
0.0*3
•0.51)
0.077
•0.2)7
•1.6*8
-0.60)
0.80)
•1.25)
-2.0*4
—1.418
-0,'22
-0.80*
-*.*72
-3.000
-2.M8
-1.)55
-0.61*
•2.3)0
•2.108

rrtTf 4

•rrrorrica

cross rv7.
oanrsTic

rrtsoML

INVFS7MFNT SAVING MTt

LOCAL

0.')6
0.051
•0.281
•0.421
-0.13'
-0.01'
0*0)4
-0.30)
-O.)18
•0.207
•0.306
-0.52)
•0.041
0.012
•0.070
0.082
0.077
0.15ft
•0.001
0.06ft
-0.132
0.010
0.159
0.180
0.234
1.138
1.012
0.474
0.353
0.064
1.4*3
1.3"
1.108
1.108
1.2*9

0.'01
0.323
0.064
0.0*2
0.323
-0.0*7
-0.*24
O.*oo
0.201
1.174
0.208
-0.723
-0.630
-0.070
0.225
0.079

16.381
16.501
15.277
14.797

3.108
5.900!
'.000 .
5.800
7.100
7.300
7.300
6.600
6.000
7.300
7.200
7. '00
ft. 200
5.600
6.300
6.000
5.* 00
6.700
7.100
7.000
8,100
7.100
*»*00
8.000
8.100
ft. 500
8.600
8.500
8.600
6.000
5.600
5.200
5.200
5.600
5.300

-0.1«ft
•0.22)
0.0*9
0,058
0.6*)
1.147

0,054
. 0.*52
0.705
0.2)2
0.27'
•0.182

14.73'
14.87)
14.289
1'.'))
1'.O41
15.6)8

ft. 8*0
•.7*0
•.300
7.320
8.060
5.700

3.48*
0.930
0.339
%0.6«5
0.26ft
0.180
•0.3*8
0.0*2
0.111
0.655
1.083
0.149
-0.2)4
0.557
0.728
8.600
0.7*0
1.070
0.70*

14.767
15.856
1*.8*7
16.*16
1'.774
1'.075

i'.*23
14.700
15.60*
15.728
15.284
14.101
14.853
10.300
13.813
14.010
14.23'
1'.385
15.001
1*.758
1'.069
1'.360
14.773
14.202
14.733
15.583
15.0)1
14.05ft
13.7*0
14.321

15.709

rra m» Avtfiors
•MMMM

i«Iw
16.342
161*87

T.W

7.70)
•.'68
8,100
7.711
1.781

2.*3I

•MM**

5.M*
M14

3.017
1.988
2.338

stoS)
5.72)
••")

3.820
).90)
3.*71
3.288
3.572
3.979

-O.'ftl
-0.21*
-0.328
•0.524
•1.189
•0.764

oloo7
-0.377
-0.587
•1.832
•1.961

152
Table 2

t/9/12

•rr tames
fuccffT or

f WCOTT

1947

i4«e
1949

1950
1951
1952
1953
195%
1955
1956
1957
1958
1959
1960
1961
1962
1963
196«
1965
1*66
1967
1968
1969
1970
1971
1972
1973
197»
'1975
1f76
1977
1978
1979
1940

TOTAL

Htxttit

11.29
12.36

••54

4.61
4.83
7.28
7.28
7.79
•.03
7.47
7.59
•.10
•.34
4,10
7.42
7.89
•.89
7.43

7.31

0.04

5.86

10.32
f.79
4,4*
9.40
9.45
8,9*
9.71
•.33
4.72
7.53
7.57

7.M
•.75

10.10
9.59
0.15
7.98
•.52

••43
•.52

7.74
9.13
10.02
9.77
10.09
•.72
7.37

•Iso

9.84
T.23
4.29
9.37
4,27
••93
T.28
4.85
9.04

7.70
9.20
7.59
•*48
T.74
T.34
•.94
4,72
4,23
4,00

7.33
7.57
•.11
•.17 7.05-

7.83
7.81
•.47
•,75
•.T7
4,99

-7.40

fCfSONAL COUWF-ATt STATE 4 LOCAI rtOtftAL

2.43

2*18
4.17
4.11

4.65
1.16
4.53
9.29
9.45

2*73

a.5o

2*57
2*15
2,51
1.60
2*79
1.54
2*02
1.11
2*12
2*61
3.53
1.74
4,08
4.72
4.40
4.05
1.49
2.47
1.43

9.51
9.08
4.50
9.57
5.54
9.80

4.77

4.27
4.42
4.51
4.01
9.05
5.30
9.17
4.04
9.23
4.70
•.17
4,18
4.87
4,53
4,56
••78
9.35
4.30
1.95
1.99
4.33
4.10

2*83
2,67
1.03

a.09

2*39
1.03
2*99

t.n
1*89
1.90

rxtt
1951-1955
lfSt.1960
1961*1965
1964.1970
1971.1975
197U1980

••14

f iznn *vw
•AHIK3

OF IIT lATXOHil. ffOOUCT

9*Tf
5.19
4.74
5.44
4,18

••36

0,47
0.06
•0.31
•6.46
•0.15
•0.01
0*04

•6*33
-0.33
•4.23
•4.34
-0.58
•6.10
0.01
•4.06
0.09
0,01
0.17
0*00
0.07
-0.14
0.01
0.17
0.21
0.26
1.25
1.11
0,52
0.39
U07
1.63
1.50
1.21
U24
1.40

4,20
1.48

•1.12
1.50
2*14

•1.17
•2*11
•1.81
1.21
1*54

0*57
•1.53
•6.26
0.66

•4.81
•4.12
0.05

•6.56
0,03

•6.26
•1.40
•6.75
0.98

•1.37
•2.24
•1.56
•6.46
•6.89
•4.9ft
*-*.49
•1.51
•6.69
•2*62

fECOAL
122.11
19.12
•94,00
91.35

•••05

•44.63
•87,32

15,41
f9.49
T.30

•ll30
9,55

•11.07
•10,12
0*40
•4.01
0.83

•2.61
•14.06
•4.64
12*94
•17.17
•25*40
•17.40
•10.94
•53.77
^9.04
•17.89
•4.42
•35.03
•31.98

TEA* Am fcCCS
2*67
2,42
1.73
1*29
2.19
2.61

•6.16
-0.25
0*05
0.06
O.T1
U34

•6,35
0.01

-0.41
•6.64
-2.03
-2,19

^44
—6,37
•5.15

•4.71
•22.44

•26.13

SIL

Budget Deficits in Relation to GNP51
Percent

1 -

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987
- Actual * On and off budget as percent of fiscal year GNP.

- Projected -

Budget Deficits in Relation to GNP
Fiscal Year

Deficits
(Bil. of dols.)

Percent of GNP

1975
1976
1977
1978
1979

-53.2
-73.7
-53.6
-59.2
-40.2

-3.6
-4.5
-2.9
-2.8
-1.7

-73.8
-78.9

-2.9
-2.8

-118.3
-107.2
-97.2
-82.8
-77.0
-62.5

-3.8
-3.1
-2.6
-2.0
-1.7
-1.3

1900
1981
1982
1983
1984
1985
1986
1987
Note:

actual
projected

Figures include off-budget entities,

3/23/82

Interest Rates and the Relative Size of the Deficit
Percent
15.

3-Month
Treasury Bill /i
Rate
\

A.
x/

Deficit as a Percent
of GNP*

1956

1958 1960

1962

1964

1966

1968

1970

1972 1974

Fiscal Year
* Federal surplus or deficit includes off-budget items. Points below zero line
represent surplus as percent of GNP, points above line a deficit.

1976

1978

1980

Projected Borrowing Requirement
in Relation to Private Saving

Billions of
Dollars

700

600

Federal Borrowing
Requirement*

500
Gross Private
Saving

400

300

200 h-

100h

1975

1976

1977

1978
1979
1980
- Actual Fiscal Year

1982

1981
•

* Total budget deficit including off-budget entities.
Note: Saving flows do not reflect surpluses of state and local governments or inflows
from abroad.

1983

1984

Projected

March 24, 1982

Projected Borrowing Requirement in Relation to Private Saving

Gross
Federal
private
deficit including
saving
off-budget
(—-billions of dollars
)

Fiscal
year
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984

actual
projected

Deficit as
share of
saving
(percent)

253.4
295.6
309.8
347.4
392.2
423.0
462.3

-53.2
-73.7
-53.6
-59.2
-40.2
-73.8
-78.9

-21.0
-24.9
-17.3
-17.0
-10.2
-17.4
-17.1

523
624
712

-118.3
-107.2
-97.2

-22.6
-17.2
-13.7

3/23/82

Consumer Prices
(percent change from year earlier)

1976

1977

1978

1979

1980

1981

1982

Producer Prices

percent

(percent change from year earlier)

Finished Goods / -.

.,
»» »»

v*/ '5

/ i,
C71

'1976

1977

1978

1979

1980

1981

1982

Current Law Tax Reduction vs. Quick Fix Alternative
Worker with $20,000 in Wage Income in 1982 Rising with Cost of Living
Percent
10.5

Effective Tax Rate

10.07

10.0
Quick Fix

9.51

9.5
^

9.0 -

8.93*

8.88^*
^"""•••••••^

i.50

8.5 -

Current Law

8.27

8.25

8.24

1984

I
1985

I
1986

I
1987

8.0

1982

1983

Quick Fix alternative leaves the July 1, 1982 tax rate reduction in place,
but cancels the July 1, 1983 tax rate reduction and indexing.

Percent

1957

RATES OF CHANGE OF MONEY AND PRICES

1959

1 1 1 1 m l Mil
1961
1963

1 1 1 1 1 1 1 1 Imlliii 11 n Im Ll
1965 1967 1969 1971 1973 1975 1977 1979 1981

!/ Four-quarter rate of change;
21 Twenty-quarter rate of change; data prior to 1st quarter 1964 are M1.
Latest data plotted: 4th quarter

Percent

J«>u*y?;. »982 A164

Mi VERSUS TARGET RANGE
470 5 1 /2%

460 -

8.5%
450 -

440 ~

430 ~

420 -

410 -

I
1980

1981

* Weekly Averages-Seasonally Adjusted

I
1982

INTEREST RATES AND INFLATION

75
* Growth from year earlier in GNP deflator.
Plotted quarterly.

MONTHLY CHANGE IN MONEY SUPPLY

Percent

.tlllllllllltlllllllllltllllllllllllllllllllllllllllllllMltlf

•••••••••••••••••••••••••••I

•Illlllllllllllllll

(••(•••••••••••••••••••••••••••iiniiiiiiii

—.5-

1978

1979

1980

1981

Quarterly Rates of Growth of Monetary Base and the Money Supply (M1)*

Percent

Monetary Base
(St. Louis)

1979

1980

1981

Weekly
* Quarterly growth rates based on four-week averages compared with four-week averages
thirteen weeks earlier, at annual rates. Latest week plotted: March 3 for M1, March 10
for monetary base.
NOTE: Monetary Base data do not reflect recent revisions in the series by the
St. Louis Federal Reserve.

1982

Monetary Base Growth vs. 3-Month T-Bill
18

3-Month Treasury
Bill Rate
(right scale)

Monetary Base
Growth*
(left scale)

I I I I I I I I I I I I I I I
31

I I I I

• 20 26 26 22 20 17 16 12
9
JAN FEB MAR APR MAY JUN JUL AUG SEP
1981

*52 Week Growth on 4-Week Moving Averages
NOTE: Monetary Base data do not reflect recent revisions in the series by the
St. Louis Federal Reserve.

I I I I Vr I I I
7
OCT

I I

4
2
30 27 24
NOV
DEC JAN FEB
1982
March 24,1982

THE THREE-MONTH TREASURY BILL RATE AND GROWTH OF Mt
• Percent

Percent -

18
16
14
12
10
• computed by log regression* on lime

8
6
4
2
0
-2
-4

Jan.

Feb. Mar. Apr.

May Jun. Jul.
1981

Aug. Sep. Oct. Nov. Dec.

Jan. ~6
1982

INTERMEDIATE AND LONG MARKET RATES
Weekly Averages

New Conventional
Mortgages x

jam,

^.«

Treasury
20-Year

12j

Through March 19

9
8

9
ll I I I i l l I I I ll I I I ll

I I I

Jan

Feb

Mar

Apr

Note: Mortgage data plotted monthly

May

June July
1981

Aug

Sep

Oct

Nov

Dec

Jan

Feb
1982

Mar

SHORT TERM INTEREST RATES
Weekly Averages
Prime Rate
20

16-

12-

I I II

Jan

Feb

Mar

Apr

May

Jun
Jul
1981

Aug

Sep

Oct

Nov

Dec

Jan

Feb
1982

Mar

170

The CHAIRMAN. It was reported in the New York Times on
March 26 that you had won a fight within the administration to
avoid including revised economic forecasts in the administration's
April 10 letter to Congress containing the administration's reestimates of future deficits.
Was that an accurate report, incidentally?
Secretary REGAN. I don't think there was any fight. There was a
discussion within the administration as to what should be in the
letter that, as you know, by law has to go to the Congress.
The CHAIRMAN. Let's say it was a discussion and debate. Let us
say there was a dissension and
Secretary REGAN. There were differences of opinion.
The CHAIRMAN. Oh, all right. You prevailed.
Secretary REGAN. Let us say that we are not going to submit
those. I don't think we have to go through that exercise again until
July.
The CHAIRMAN. All right. Now we know that Mr. Weidenbaum
feels that unemployment will rise no more than 9 percent. Mr.
Kudlow says that recovery will not be as strong as the administration has predicted. Now, we are told that. Did you meet with the
President earlier this morning to discuss the economy again?
Secretary REGAN. No; I did that last Friday.
The CHAIRMAN. OK. At that time did you give him an economic
forecast in terms of real GNP interest rates, unemployment, and
inflation for those items discussed?
Secretary REGAN. No; I did not because we already have in place
our forecasts. I brought him up to date on what was happening in
the economy.
The CHAIRMAN. Would you share with this committee your forecast as far as GNP is concerned between now and what will be?
What is your economic forecast for real GNP between now and
September of this year? Can you share that with us?
Secretary REGAN. The Commerce Department flash indicates
that their preliminary figure is minus 4.5 in real growth for the
first quarter of calendar 1982. We believe that the second quarter
will be a plus quarter but not very strong, perhaps between zero
and 1 in that area. We are expecting a recovery somewhere oh, 4.5
to 5, in through there, for the third quarter of 1982.
The CHAIRMAN. With respect to interest rates between now and
September of this year, would you give us your own forecast as to
what we might look forward to? That is a very, very important
point.
Secretary REGAN. I understand that. I spent 35 years on Wall
Street ducking that question.
The CHAIRMAN. You are now Secretary of the Treasury.
Secretary REGAN. I understand that. Even the Secretary of the
Treasury is not very precise when trying to project interest rates. I
would say, Mr. Chairman, that I think that interest rates will probably start down, if any movement is seen on getting the deficits
down.
I think that is one of the reasons they are high now. I think that
if there is an indication that the administration and the Congress
can work together, to get these deficits down, you will start to see
interest rates start down.

171

The CHAIRMAN. The President submitted a budget and the President has made a point that he and you reiterated this morning the
fact that you don't think we should touch in any way, shape,
manner, or fashion the tax program that was enacted last year.
The President stated that he would not agree to any decrease in
military spending.
Given those facts and given the deficit projections by the administration, as well as by the Congressional Budget Office, I would
ask you for your projection on interest rates, having those thoughts
in mind.
Secretary REGAN. Well, let's put it this way. I can't give a simple
answer to that. First of all, regarding our tax program, we didn't
say that in no way, shape, or fashion could it be changed. As a
matter of fact, we have sent up to this Congress recommendations
for tax increases in the neighborhood of about $13 to $15 billion.
In addition, the President reiterated again yesterday something
he has been saying for the last several months, that if the Congress
can show him a comprehensive program that would improve the
outlook for the budget, he would be more than willing to look at it.
He is saying that the need to do something about these deficits
goes beyond parties. So, I would suggest that if there were such a
program that certainly it would be given the most careful consideration at the highest levels.
The CHAIRMAN. But the point is
Secretary REGAN. The point is
The CHAIRMAN. Wait a second. The point is that to date there
has been a lot of discussion back and forth but no movement. As
far as the general public is concerned and the investing public, all
we know of is the submission by the President to the Congress of a
budget.
Now, given that, I ask you what your projection is. Certainly you
subscribe to the budget that was sent here by the President. Under
those circumstances, what are your projections between now and
September of this year, if there is no change in that budget?
Secretary REGAN. If we could come up with a deficit of $90 billion, as was approximately called for by the President, if that is
what the Congress votes and does that, I think that interest rates
will come down sharply.
I think the markets are anticipating deficits higher than $90 billion.
The CHAIRMAN. Even the administration agrees at this point that
that deficit will be higher.
Secretary REGAN. Mr. Stockman sent up a letter saying that it
would be about $4 to $6 billion higher due primarily to the CCC
program, which is running $4 billion higher for various types of
commodities that are going into storage, and also because of the
higher rates of interest that are staying consistently high.
The CHAIRMAN. All right. Now unemployment is now above 9
percent; in Rhode Island, above 10 percent. What can we look forward to between now and September of this year on unemployment, given the budget that we are faced with, the only budget we
are aware of at this point in time?
Secretary REGAN. I would say we are forecasting unemployment
to top out right around this range, in the 9-percent area, let's say

172

somewhere in that range, give or take two- or three-tenths of 1 percentage point one way or another that would top out in that area.
The CHAIRMAN. You feel at this point it has peaked?
Secretary REGAN. Not peaked, but in the process of it. As I say, it
is very hard to be precise here on tenths of 1 percent. Since it is a
lagging indicator unemployment will not come down as rapidly as
interest rates will, and as other things, such as the leading indicators, will perk up. I would suggest that unemployment as a result
will probably stay above 8 percent between now and September.
The CHAIRMAN. So you are stating, if I can make sure I get this
clear, that if indeed the President's budget were to be adopted as
presented that interest rates between now and September would
drop sharply?
Secretary REGAN. Yes.
The CHAIRMAN. Thank you.
Mr. Stanton?
Mr. STANTON. Thank you, Mr. Chairman.
Mr. Secretary, I extend to you a warm welcome for your first appearance before this subcommittee and congratulate you on your
statement.
May I make the observation that I am delighted you didn't get
into some bidding war on interest rates. Your predecessor in the
last campaign changed his mind seven times on interest rates. I am
delighted that you didn't get into that subject.
The observation of the relationship between the administration
and the Federal Reserve Board I thought best might be put to rest
here.
During the last couple of weeks when the new member of that
Board, Mr. Preston Martin, appeared before the Senate, it seems to
me that in his confirmation he stated that he basically approves of
the present policies of the Federal Reserve Board.
I am sure that the President wouldn't have appointed him to
that Board if he wanted someone with different views. Wouldn't
you agree with that?
Secretary REGAN. Yes; as you noticed, Mr. Stanton, I said in my
prepared remarks that we generaly agree with their policies, the
2.5- to 5-percent range for 1982, with a recommendation that they
stay toward the upper part of that range during most of the year.
Mr. STANTON. I want to keep this moving, Mr. Secretary. In this
morning's paper it alluded to the housing task force that the President had asked for and reported to him. It is my understanding
that there is quite a similar task force taking place on the thrift
industries problems.
Am I right in that? Do you have a deadline to report to the
President with recommendations or is that a wrong assumption?
Secretary REGAN. What has happened here is that the Cabinet
Council on Economic Affairs, which I chair, has had the responsibility for monitoring the thrifts ever since we took office because
right at that point the thrifts were in perilous condition and they
remained that way.
So, we are constantly monitoring it. There is no particular task
force that has a certain date they are supposed to come in.
There is a working group of assistant secretaries, under secretaries and the like, who monitor the thrift industry on a week-to-week

173

basis and report to the Cabinet-level Council on Economic Affairs
once a month.
The CHAIRMAN. Is this a large group that works on this problem?
Secretary REGAN. I would say there are seven or eight members
to it. There are representatives of the Treasury, OMB, Labor, Commerce—I am trying to think. I know that the White House has a
member on it. There are several other departments that have
members on it.
Mr. STANTON. Thank you, Mr. Secretary.
The CHAIRMAN. Mr. Reuss?
Mr. REUSS. Welcome, Mr. Secretary.
You have testified that both the administration and the Fed
agree on the super-tight 2.5 to 5.5-percent monetary course, a
course which, as you know, I think is wrong. In fact, we are now
approaching the end of the first quarter of 1982, and the Federal
Reserve in fact has created new money at double the ceiling rates.
The ceiling is 5 percent. They have created it at 11 percent. That
means that for the remaining 9 months of this year the administration and the Federal Reserve will be enforcing an even crueler
diminution of the money supply.
Do you really think that you are on the right course?
Secretary REGAN. From where the Fed is now, slightly above
their target
Mr. REUSS. Double their ceiling?
Secretary REGAN. The last 15 weeks it is down to 8.5 percent. So
they are starting to take that January bulge out of the money
supply. If they go to a 4-percent rate for the next 3 or 4 months
and then continue at a 5-percent rate, they will come right out in
the high side of their target, which is exactly where we would like
to see them.
Mr. REUSS. Well, I believe you are heading for continued disasters by your refusal to adopt a reasonable rate of monetary growth.
I come now to my second point. Admittedly the money growth of
the Fed has over the short term, during 1981, been volatile. It has
bumped up and down. You have a chart here showing that up until
October 1979 it wasn't at all volatile. After October 1979 it got very
volatile.
Now, all during last year there was testimony by the administration, by the Treasury, by Mr. Stockman, by Mr. Weidenbaum, by
Under Secretary Sprinkel and many others, including yourself. Not
one of them made the slightest complaint during 1981 about volatility. Indeed, the general administration testimony was: Don't
worry about volatility on a month-to-month basis, you have to look
at it on an annual basis.
Now, in 1982 you, Mr. Secretary, have taken the position that
the Federal Reserve is way off base, somehow, for its volatility.
You say on page 11 of your testimony "Volatile money growth undermines the credibility of long run monetary controls."
My question: Why didn't you tell us that during 1981?
Secretary REGAN. I will try to find you the citations for this. I
am sure that I did talk about it. I thought the chairman in some of
the headlines that he had clipped from the Times and other things
would go back a little further.

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I criticized the Fed, if you will recall, at the end of August 1981
and was promptly taken to the woodshed by most people, including
most economists.
Mr. REUSS. What did you criticize them for?
Secretary REGAN. Too tight a money growth.
Mr. REUSS. But that has nothing to do with volatility? You were
right, briefly.
Secretary REGAN. At the same time I was so critical of their volatility that I likened it in a speech to a golfer. This story became so
famous that Paul Volcker's daughter actually drew a picture of
this and I have it signed by him.
I am not sure, Mr. Reuss, that you are a golfer, but as one who
loves the game, you start off, and this is your fairway and here is
your tee and you shank one off the tee into the woods. Then you
come out of the woods and cross over here into the rough on this
side of the fairway. Then you land up near the green in a sandtrap.
Then you sink one from out of the trap and you have a four and a
par four. You say I have got my par.
That is exactly what the Fed did last year. They came out slightly under their target, in their range, though, but they did it by the
worst volatility I have ever seen. They were up to 12 or 13 percent
the first part of the year. They were almost zero growth from April
through October. Then they pumped it up again in November and
December. So the volatility was there.
[Secretary Regan subsequently submitted the following additional comment for inclusion in the record:]
ADDITIONAL COMMENT RECEIVED FROM SECRETARY REGAN
My concern about the volatile growth of the money supply followed explosive
growth last spring, and a falling money supply in early summer. There was virtually no growth for the 6 months ending in October, 1981. I raised these concerns first
in private discussions with the Fed, and more publicly beginning last August. In the
November to January period, money grew very rapidly, at rates approaching 16 percent per year. My Joint Economic Committee testimony on January 27 contains a
more detailed statement of the volatility program.

Mr. REUSS. If I take up golf again, a pastime I admit I have been
forced by the pressure of duties to quit doing
Secretary REGAN. I also have, in the current job.
Mr. REUSS. And if you are my coach, I will want you to tell me
when I am slicing and hooking, not wait until the season is over
and then claim that that is what was wrong with my 36 point
handicap.
Anyway, please either furnish me or the committee with some
evidence that you were sounding the alarm on this volatility
during 1981 when it was occurring. Unless you do that, let's not
hear anymore of it because it really is a copout.
The trouble with the administration is that it endorses the Federal Reserve's too tight monetary policy. The trouble is not that
there is volatility. Volatility is what comes from the October 1979
reform, which everyone—you, I, everybody on this committee—approved of.
So, let's not dump on volatility. The real evil is the too tight, too
extreme corset in which you and the Federal Reserve are placing

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this country. That is what is causing the bankruptcies, that is what
is causing the unemployment, the deficits.
Secretary REGAN. I have to disagree slightly there, Mr. Reuss. If
you ask the Wall Street traders, the international money traders
and the like, treasurers of corporations and the like, ask them
what worries them about the money supply, they will use such
words as uncertainty, volatility, and the like.
This does have quite an effect on interest rates inasmuch as
there is an uncertainty premium. They don't know what is going to
happen. Were the conditions a lot smoother, as the Fed is trying to
do, and if they were to achieve that goal, there would be a lot less
of this uncertainty.
As a result, I think you would have some of that real rate volatility premium out of interest rates.
Mr. REUSS. I have asked the traders—I have even talked to
people at Merrill Lynch—and what they tell me is the big trouble
with uncertainty is that you and the Fed pose unrealistically low
targets. Then the Fed goes over the target and of course it drives
them bonkers.
But that is another day. My time is up.
The CHAIRMAN. Mr. Wylie?
Mr. WYLIE. Thank you, Mr. Chairman.
Just before you appeared, Mr. Secretary, the majority leader was
just ahead of you. I did not get a chance to question him, but I
wanted to say to him that he is a very articulate spokesman for his
position.
He suggested that the culprit for high interest rates is the tax
cut program, and you have a difference of opinion on that. He also
suggested that Mr. Volcker is adding to the problem with his tight
monetary policy. He even went so far as to suggest that maybe Mr.
Volcker ought to resign unless he adopts more accommodating
monetary policy.
I wanted to tell him I respectfully disagree with him, as I do
with the distinguished chairman of the Joint Economic Committee.
I note on page 11 of your statement, which you presented ahead
of time, that faster growth of the monetary base produces faster
growth of M-l and is associated with rising interest rates. Slower
growth of the monetary base leads to slower money growth and
falling interest rates.
I noticed an article in the Washington Post this morning that
says, "Yields on short-term Treasury securities went up yesterday
after declining for 3 of the previous 5 weeks. The rise followed a
$500 million increase in the money supply last Friday." So interest
rates went up with this increase.
I also wanted to ask him this question: M-l growth during the
past 12 months has been over 6 percent. During the past 3 months
it has been over 9 percent. Just how fast should he think money
growth should be?
Do you think that would have been an appropriate question,
given the scenario that developed with his statement?
Secretary REGAN. I think you are entirely right on asking that
question, Mr. Wylie, because we used the adjectives tight, easy,
loose, and so forth in a very imprecise fashion.

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The Fed literally has not been too tight with its money over the
past 3 months. As a matter of fact, if anything they have been too
loose with money. Yet, they are condemned for that.
I would like to go back to your first point that you made and to
respectfully disagree with the majority leader that tax cuts lead to
deficits. If that is the case, then you are saying that the working
man, the average American Joe out there in the street is causing
the deficit.
Now, I fail to understand how the average working man in the
country is causing this deficit. I think that deficit is caused by us,
the Congress and administration, spending too much money.
As much as anything else, that is it. Certainly not by cutting a
guy's taxes are you causing an increase in deficit unless we—that
is the Federal Government—own all of the money in the world and
everybody works for us.
I have to disagree with that statement.
Mr. WYLIE. I disagreed with it, too, and wanted to say so. I
happen to think the real culprit for high interest rates is the huge
budget deficit right now and the anticipation that it is going to be
even larger.
I think that as a member of Congress we have a responsibility to
try to help the administration, try to help the President bring that
deficit down. In that connection I have suggested that maybe there
ought to be a reduction in defense spending, which I have said to
you before when you appeared before the Joint Economic Committee, and perhaps even an excise tax on tobacco and alcohol.
I have now added maybe a tax on luxuries like that which we
had during World War II. Would you care to comment on that?
Secretary REGAN. Well, I would put it this way: Again, if you put
on too much in the way of excise taxes, again that is going to cut
down on consumption. Cutting down on consumption as we start to
come out of a recession might be self-defeating at this particular
time.
I think there are other ways to raise whatever revenues are advisable in ways that wouldn't be as counterproductive as perhaps
direct excise taxes might be.
Mr. WYLIE. You mentioned one in your testimony. You spelled
out the beneficial effect of improved growth rates on the economy
of revenues and lower deficits, as you put it. Then you suggested
that you favored borrowing to finance the deficit rather than rescinding or deferring the tax cut.
Isn't borrowing to finance the public deficit part of the problem
we have vis-a-vis high interest rates now?
Secretary REGAN. Yes. Obviously if we are going to have a deficit
and we take that as a given, we in the Treasury have to get that
revenue somehow or another. If we get it by taxes, going as they
are now about 20 percent of GNP, we think that the tax rates, will
become so high that it will discourage increases in work effort
saving, and investment. They will say what is the use? Government
will take it away from us.
That has happened time and time again in other countries. It
leads to tax cheating. It leads to all kinds of endeavors to get out
from under the burden of taxes.

177

On the other hand, if we borrow, certainly we will be competing
with American industry for whatever pool of savings there are. But
we think that with the incentives of the tax cut the annual rise in
savings will exceed the size of the deficit; in other words, savings
will grow faster than the deficit, so that there will be an increasing
amount of money available for business; not as much as if we had a
smaller deficit, but nevertheless sufficient, we think, to handle it.
Mr. WYLIE. I have one more question. I was called out a little
while ago by Mr. John O'Neill, president of the National Association of Industrial and Office Parks. He says current market conditions are terrible and nothing new in the foreseeable future will
allow anything to come into the pipeline.
He suggests something which the home builders said to me. He
said, ' 'Lowering of the Federal discount rate to recognize realities
of the marketplace might help bring interest rates down."
Now, I don't happen to think that would be the answer to it, but
I would like to have your comment.
Secretary REGAN. I don't think that is particularly what is
needed at this point. The discount rate will come down automatically as other rates of interest start to come down.
Again, I think the whole key—I am sincere in this, not just posturing—I think the whole key here is the size of the deficit. I think
that is the main worry that the money markets have at this point
and is holding up the fall of interest rates, which traditionally
should be falling since we have got inflation down this much.
Mr. WYLIE. Thank you very much.
The CHAIRMAN. Mr. Gonzalez?
Mr. GONZALEZ. Thank you.
Sir, when I got the notice of this meeting a week or so ago I had
thought of preparing some questions, mostly questions having to do
with the Chinese fortune cookie predictions that you and other administration spokesmen have been giving out on the economy and
so forth.
But then I read your statement, and I wanted to thank you for
having submitted it in time to examine it before the meeting. Right
off the bat, on the first page, you say, "More importantly, we have
in place a sound, long run tax system for the 1980s."
Now, any man or woman that would come before us with that
kind of a statement is beyond remedy. There is no use asking questions. It just can't be that you are that obtuse.
So, the only thing I can ask occurred to me as I was listening to
you, and you pointed out that as having been identified, as you
have been, with this great market operation, and on page 7 you
have the statement, "I am surprised that others in commerce or industry do not appreciate the importance of the individual in the
roles of employee and customer."
I don't know if you can, but can you tell us specifically who you
are speaking of? Don't you come from the middle of that general
section of the economy known as "employers in commerce or industry"? What do you refer to there? I am surprised that others in
commerce or industry do not appreciate the importance of the individual?

178

Secretary REGAN. I will be glad to. You say I am beyond redemption. If you mean that cutting taxes makes one ready for the gates
of hell, I think that is a hell of a statement to make.
Mr. GONZALEZ. Oh, no, sir.
Secretary REGAN. I do think that what we have crafted
Mr. GONZALEZ. That is not what you said. That is not what I
quoted. You are talking about a sound, long run tax system for the
1980's.
Secretary REGAN. That is what I believe it is.
Mr. GONZALEZ. And I am saying that anybody that has taken
place and proudly admits to a $750 million giveaway in a 5-year
period to the biggest vested interest of this country—and you are
talking about the individual little taxpayer that is getting nothing
in the way of tax cuts, at least not even meaningfully for the first 3
years—has to be either obtuse or just a member of the modern day
cult, because we have a cult known as Reaganomics.
Secretary REGAN. I am proud to be a member of that cult.
Mr. GONZALEZ. That is what I am saying. But don't distort the
criticism. Don't say that that means that immense task reduction
because that is not what we are talking about. I am talking about a
statement, a categorical statement that in the light of what actually happened has presented the country.
You can say that that is my interpretation, but this seems to be
the conclusion of many, many preeminent experts that are not in
politics that it now represents one of the most regressive tax systems of any country, not just the United States; very regressive to
the point of unfairness. After all, the hallmark of a good tax is fairness.
That is what I was referring to. So you know it doesn't surprise
me, in anticipating answers to questions, but for you to now follow
through and obviously distort the thrust of my questioning of that
statement I think adds insult to injury.
Secretary REGAN. I think the tax cut we made was fair. It was
across the board. An equal percentage for everybody. What could
have been fairer than that? We coupled that with a very fast depreciation schedule in order to modernize business, to make it
more productive, to try to get more jobs available for people. I
think that was well done.
What I was referring to in my remarks about industry and commerce, and people of that nature, is that there have been statements by business leaders, particularly those in the Business
Round Table, urging that the third year tax cut be done away with
but the business tax cut preserved.
That is what I don't understand, how business can say take the
tax cut away from an individual but preserve our tax cut for us,
realizing, or not realizing, that the laborer and the worker who
would be taxed higher as a result of this is their customer and
their consumer. If they don't want that person to have the money,
they want us to have it here in the Federal Government to spend. I
just don't follow that line of reasoning in commerce and industry.
Mr. GONZALEZ. But sir, even the President, if I recollect correctly
what he said not too long ago, was admitting that there was need
for some revision, some correction I think is the way he put it, of

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some of the tax features that were included in what you say is a
perfect tax measure.
Am I not correct in saying that?
Secretary REGAN. No. What we are saying is that we are not correcting any of what we did last year. There are other sections of
the code that were previously enacted, or interpretations of the
code that have been thought up since the laws were passed by the
Congress.
I will give you an example of what I mean, Mr. Gonzalez. In the
paper this morning you may have noticed that the Equitable Life
Insurance Co. paid no taxes whatsoever last year, in spite of the
fact that the year before they had paid millions and the year
before that hundreds of millions in taxes, all because of an interpretation of the code called a modification for insurance companies
in which they changed their method of accounting and set up separate corporations to co-insure.
Now, that is an interpretation of the code that was never approved by this Congress. That is an interpretation that was never
approved by the IRS. It is something we are asking the Congress,
therefore, to change so that these people will pay at least a minimum tax, like you and I do.
It is that type of thing, that we have suggested to Ways and
Means for additional revenues for fiscal year 1983.
Mr. GONZALEZ. I recall the President was addressing himself specifically to the tax bill that was passed last year. I think with reference to the purchase of these tax credits
Secretary REGAN. On leasing. It may well be that leasing will
have to be modified in view of experience. We don't know. We have
a further study coming out. We have issued our initial ones.
There have been proposals from some that we abandon leasings.
The airline companies tell us if we abandon leasing, they can't
come up with any new equipment. The steel companies tell us the
same thing, as do some of the other types of industries.
Automobile companies in particular say don't do away with that,
don't modify it. So we are looking at it from both sides at this particular time.
The CHAIRMAN. Mr. Evans?
Mr. EVANS. Thank you, Mr. Chairman.
Mr. Secretary, I must admit that I have to make my pars these
days in the manner you described, out of a sandtrap. My handicap
has gone from two to eight and is still climbing in the short
number of years I have been here.
I was not here for the distinguished majority leader's testimony,
but I understand that he described the tax cuts that we enacted
last year as monstrous in nature.
I would just like to point out for the record that the 5 percent
tax cut that went into effect October 1 meant we had a 11A percent
reduction for 1981. Since this is the last day or close to the last day
of March, we have had an additional IVi percent, which amounts
to a current total of 2Vfe percent. That is not even enough to offset
the increases in the social security taxes that went into effect in
January. It seems to me that we have not given that tax cut and
that tax incentive and that stimulus time to work.

180

Mr. Secretary, would you care to comment a little further on
what a deferral or rescission of the personal income tax cuts might
mean to the financial community and to others?
It seems to me that we need some stability in this economy, and
that is one thing that the President is bringing to it. His program
is fundamentally sound, but that doesn't mean we can't make some
tactical modifications to perhaps make it even more sound and preserve its credibility.
In my opinion, to defer that tax cut now would be spectacularly
ill-timed in view of the recession that we are in. Could I have your
comments, sir?
Secretary REGAN. Yes, first of all, as you know, Mr. Evans, on
July 1 of this year all taxpayers get another 10 percent cut. Since
we are in a recession and by that time will be just emerging from
the recession, even a Keynesian would say that has to be well positioned at this particular moment in order to stimulate the economy.
Mr. EVANS. If you will yield, sir, there have been some who have
suggested that we defer that tax cut, even the tax cut for 1982. I
just think that would be going in the wrong direction.
Secretary REGAN. That would be absolutely the wrong direction
because we do need stimulus to the economy. We do need not only
more spending, but we need more savings and we would get neither if the Federal Government hangs on to that money.
The second tax cut comes July 1, 1983. There again, hopefully,
we will be in a more prosperous time. But if you consider why
should that one go
Mr. EVANS. I think we will reach more prosperous times if we
are steadfast in the direction we are going, Mr. Secretary.
Secretary REGAN. I agree. Mr. Evans. In 1981 there was a 11Apercent tax cuts for individuals, as you said. This year we will get a
total of 14 percent between the 10 percent of the second half of the
year and the remainder of the 5-percent cut.
Put those together and it just about keeps an individual even
with inflation, plus the social security tax increase. So that the
first tax cut an individual literally gets is in 1983. It won't be until
then that we will give anyone a tax cut.
Why you should take the only tax cut that a person would get in
3 or 4 years away from them is more than I would know. I think
that the taxpayers deserve that break.
Mr. EVANS. I agree with you. I think they do deserve that break.
Mr. Secretary, we are having, in the midst of this recession, an
unusually difficult time for some industries; the automobile industry, the real estate industry, the homebuilding industry.
I have heard a number of proposals to help specifically the home
buyers, the homebuilders, the realtors. They have historically led
us out of a recession. I think they can lead us out of this one.
Most of the programs that I have heard would aggravate an already bloated Federal deficit rather substantially. If we could come
up with something realistic that did not aggravate that budget deficit, you would not oppose it as a matter of principle?
I am thinking of a gentleman from Texas, Mr. Gonzalez, who
talked about tax breaks for the biggest vested interest in this country. One of the tax breaks that we are providing for Mobil and

181

Texaco and some consortiums of Japanese and Germans comes
through the Synfuels Corporation and in the form of a subsidy.
It seems to me that we might consider taking some of what has
already been authorized and appropriated there and provide a
little of that for home buyers and realtors and homebuilders. I
think that would make some sense if we didn't increase the budget
deficit.
Secretary REGAN. Well, in general I would agree with the statement that whatever is done by the Congress should not increase
the deficits. They are too high now, and they should be cut severe-

ly.

As far as what we are doing for homebuilding, the President announced a program yesterday. One of the things that I would like
to elaborate on a little bit, because I am not sure people focused on
it yesterday, is ever since the start of ERISA and pension funds it
has been practically made impossible for these large pension funds
to invest in mortgages.
They have about $500 billion that are now invested. It is primarily in bonds and some in stocks. Only $7 billion of that is in mortgages out of the $500 billion. Those funds will soon grow to $1 trillion and in the out years to $2-$3-$4 trillion in size. If this condition were to persist, again there would be nothing in it for the
building industry.
In the Labor Department and in other areas of this administration we are working quickly to change those provisions of ERISA to
allow these funds to invest let's say up to 25 percent of their funds
in mortgage. That would be a pool of $250 billion of capital available.
Now, we all know the thrifts are in dire straits. We are not sure
how soon their recovery will take place and how soon they will be
back into the mortgage market with billions of dollars. In the
meantime ERISA will more than make up that slack. That is what
we are trying to do.
Mr. EVANS. I applaud the initiatives taken by the President yesterday and announced at the National Association of Realtors. I
think perhaps we could go a little bit further in providing some assistance to some industries that are in failing health these days
without exacerbating the already bloated deficit we have.
I thank you, Mr. Secretary, very much.
The CHAIRMAN. Mr. LaFalce?
Mr. LAFALCE. Mr. Secretary, let us assume, for the sake of argument at least, that the high real interest rate, the difference between the inflationary rate and the interest rate being charged, is
caused by the expectation, the probability of excessively high deficits in future years. I think most people would hold to that explanation of the long-term high real interest rates, not the short term.
How do you explain the short-term high real interest rates? The
expectation of future excessive deficits should not be the explanation for that.
Secretary REGAN. Mr. LaFalce, I think it is a combination of uncertainties; uncertainty as far as what is actually going to happen
to the deficit this year and whether or not there will be crowding
out in the near term, as far as the Treasury borrowings versus private borrowings.

182

I think the second item has to be this volatility in money supply
growth rates for the simple reason that money supply gowth is an
imprecise thing in the marketplace, they do not know what is
going to happen to it, whether it is going to be excessive or it is
going to be too tight, where they are going.
Institutions have lost money on this. I think as a result you have
this unusual premium.
Mr. LAFALCE. Let's assume we both agree that we have to cut
the deficit for fiscal year 1983 and in future years. Let's try not to
be partisan at all, either you or I. Last night, though, I saw Senator
Dole on TV, his Republican credentials are impeccable, he was
criticizing the President for being too rigid and not compromising.
This morning I read the Wall Street Journal and I saw that Senator Laxalt said in the Wall Street Journal, and his relationship
with the President cannot be questioned, that the President is
being too rigid. Both seem to be saying that we have to do something about defense cuts, and about the tax bill that was passed
last year if we are going to reduce the deficit.
Since the increase in the defense budget and the reduction in
revenues account for such a large portion of the 1983 deficit and
the expectation of future excessive deficits, if those two items are
removed from the bargaining table, it does not seem to me that one
can realistically say one wants to compromise. That seems to me to
be what Senator Laxalt and Dole were saying just yesterday?
Secretary REGAN. Maybe in answer to you I could come up with
an analogy in a different sport. If we went to play ball and I have
thrown the ball to you and you fail to throw it back to me and just
complain about the way I threw it or the size and dimensions of
the ball or something of that nature, we do not get to play ball.
You have to throw it back to me so I could throw it to you unless
you expect me to get a second ball more to your liking and throw it
back to you.
Mr. LAFALCE. It seems to me the only way we will achieve compromise is if we gather together in the same room, at the same
time, at least the following individuals: The President of the
United States, the Senate majority leader, the Speaker of the
House, and if they walk out of that same room, out of the same
door, at the same time, saying the same thing.
The political realities are such that if we are going to make
meaningful cuts, if we are going to assuage the fears of the financial markets, we are going to have to do that. And it seems to me
that the President is going to have to show some leadership in
bringing these individuals into that same room at least.
I do not think that has been done.
Let me take issue with you, if I might, in one area, and I want to
focus in on the tax bill now. You have described the tax bill as
across-the-board tax cut and ask what could be fairer? You have
also said that we need it this coming summer in order to stimulate
the economy.
One of the difficulties I think with this administration has not
been so much the legislation that has been proposed, but the rhetoric that has been used by some members or supporters of it in the
promises that they have used. I think too many promises were

183

made and associated with the program that was enacted. I think
the rhetoric of a supply-side economics has been a gross distortion.
Herb Stein, Chairman of the Council on Economic Advisers
under both Nixon and Ford, called the primary across-the-board
tax cut bill that was advocated a form of punk supply-sidism, not
true supply-sidism.
He said it would stimulate demand rather than supply. If it is to
be effective, in helping us out of the recovery this summer, and I
certainly think we do need a tax cut effective this summer, it will
be primarily because it stimulates aggregate demand as opposed to
stimulating supply. All tax cuts will stimulate both. It is a question
of what the primary effect will be.
Insofar as the fairness of the cut, that is where I take issue with
it. Not whether we should have had a cut, but the equity of it, the
distribution of it. You say what could be fairer than across-theboard. That is so simplistic.
What happened to the personal exemption? We did not touch the
personal exemption? We are going to do it, we think, in 1986 or
1985, when indexation goes into effect, modestly, but what will inflation have done to it by that time.
Of course the theory of the personal exemption is that you
should not tax that portion of a person's income necessary for his
daily sustenance. We did not touch that. That hurt the little guy a
heck of a lot more than it hurts the big guy. So it was not fair to
the little guy. What did we do for the standard deduction or zero
bracket amount? We did not touch that and inflation has eroded
that.
Of course, 72 percent of American taxpayers do not itemize. They
really need an increase in the zero bracket amount. So I can suggest a number of things that would have been fairer than the
across-the-board tax cut.
Also, when you speak of the across-the-board tax cut, you speak
of it as if it is so fair because it is the same percentage cut in one's
taxes for all. But, more than 50 percent of Americans pay more
than 50 percent of their Federal taxes through the social security
tax, not the income tax.
The across-the-board tax cuts that only impact the income tax
rather than the social security tax, will cut 10 percent of far less
than 50 percent of the total Federal tax burden for most Americans compared with 10 pecent of perhaps 96 percent of the tax
burden for the individual who is making $100,000 or more.
So on all of those scores, I find the rhetoric and the substance of
the tax cut bill that was promoted by the administration and
passed by the Congress inequitable and ineffective. I am sure you
care to comment.
The CHAIRMAN. If I may interrupt for a moment. The bells are
for a vote to approve the journal of previous day's record, and the
Chair is not going to participate in that vote. I shall stay. If Members want to go to vote and return, we will keep the hearing running. Sorry to interrupt.
Secretary REGAN. Well, Mr. LaFalce, I would say this, that one of
the things that you have overlooked is that the personal exemptions and the standard deductions have been raised several times
since 1969.

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Mr. LAFALCE. Not since 1978.
Secretary REGAN. The tax brackets have not been changed since
1965.
Mr. LAFALCE. Kemp-Roth did not change the tax brackets at all,
it changed the rates.
Secretary REGAN. The rates themselves have not also been
changed since 1965. So I think that what you are saying here is
that in spite of inflation, which I think has been primarily due to
the Federal Government—the Federal Government is the cause of
inflation—because inflation has kicked the average wage earner
into higher brackets, we should continue to tax that away.
As I pointed out in my testimony, we raised taxes $250 billion in
a 4-year period from 1977 to 1981. Then we went ahead and spent
an additinal $200 billion which ended up as deficit. I think that if
you were to keep that system up, you obviously are just going to
discourage anybody from working. You are going to make an effort
poured into tax shelters and that sort of thing much more worthwhile instead of more productive investments.
I think you have to think through how do we finance these deficits that we are creating. As a result of that, I think that you have
to come to the conclusion that the only way to do that, literally, is
through greater savings rather than monetizing the debt and causing inflation.
Unless you are prepared to do something to create savings, that
is to leave more money in the hands of individuals, you will not get
that great a savings. So our tax program was designed along that
route, to increase savings.
The business side of it obviously was designed to get a more productive United States. Our plants, equipment, so forth are gradualy becoming outmoded, and depreciation allowances could not keep
up with inflation. The net result of that is that we are now trying,
through the 10-5-3 method to get depreciation allowances closer to
the rates of inflation.
We think perhaps we will be able to achieve that.
Mr. LAFALCE. Personal exemption, by the way, was $1,000 in the
1930's. Then for World War II it was cut in order to raise money.
So right now it is still where it was at in the 1930's, Mr. Secretary.
The CHAIRMAN. Mr. Parris.
Mr. PARRIS. Thank you, Mr. Chairman. It is always a pleasure to
welcome one of my most distinguished constituents from Virginia. I
would like to talk for just a minute, Mr. Secretary, if I might about
inflation, which I know you would agree is the cruelest tax of all. I
think, very frankly, I do not mean this in any sense as a personal
criticism, I think we have done, we the Administration and those
of us who have the privilege of serving in elected office, we have
done a not very credible job of explaining the situation of what has
happened to inflation to the American people.
I regret that. Again I reiterate, I do not mean that as any criticism. Other than what we have all heard as the old example, old
perhaps now, that if you take the average three bedroom, two bath
house in your neighborhood, with a quarter acre lot, if inflation
stayed at the highest level it was in the worst quarter of last year,
by the time that $110,000 house or something is available for purchase by today's babies 35 years from now, it will cost $6 million.

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Now we have heard at some length observations of the majority
leader this morning. I think yet what we are getting is a first peek
at a disinflated economy. And the latest figures we have had is
something around 3.5 percent. I think very honestly we are winning that war.
But at the same time, we have experienced a literal revolution in
the investment climate in this nation. Overnight, basically, we
have gone from a leveraged borrowing economy to a cash and carry
economy. It is simply cheaper to have equity than it is to engage in
borrowing it at the excessively high costs that include, in my view,
a premium, still based on inflationary expectations.
My real question to you this morning is: Could you tell us how do
we reduce the premium of inflationary expectation or volatility?
What do we have to do as members of Congress? What do you have
to do as a leading spokesman of the administration to impact on
the local banker, on the financial community of this Nation, to
reduce the costs of money to the traditional historical 2 or 3 percent above the inflation rate so that we can get this interest rate
situation in hand and give an opportunity for ventilation to the
real estate business, to realtors themselves, to homebuilders, to the
people who are literally hanging on the edge of financial disaster
by their fingernails?
What would you suggest that this committee might do to have
the greatest possible impact on that at the earliest time frame?
Secretary REGAN. I think, Mr. Parris, that what we have to do—
again I come back to what I said to the Chairman and said earlier
in my prepared remarks. At this moment, the fear of high deficits
is what has money rates staying up there. Now you can go through
history and find very little tangible evidence of correlation between deficits and high rates of interest. There have been periods
in history where deficits have gone down, interest rates have gone
up. There have been other times when the deficits have gone up
and interest rates have come down.
But right now, in people's minds are deficit forecasts in triple
digits, 120, 150 million of dollars each year and raising over the
next 2 to 3 to 4 years, and they think that will cause severe inflation later, that is later in 1982 or 1983 and 1984, in the United
States.
Until such time as we can convince them that we are going to do
something about that deficit, those rates are going to stay up there.
If they are convinced that we are going to work seriously to get
those rates down, primarily by cutting Federal spending, then you
will start to see some break in those rates.
As these rates break, they will feed upon themselves and the fear
will lessen. They will start coming down, I think as the economy
revives, I think frankly as far as real estate is concerned, when
rates are somewhere in the neighborhood of 12 to 13 percent, I
think you will start to see a revival of the real estate market.
I think at that point, again, seeing that there will be more savings and the like, as our program takes effect, later in 1982 and in
1983, the fear of crowding out will -diminish. Again, that real rate
of interest premium will start to shrink. So we will be getting back
to what the normal premium should be.

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Mr. PARRIS. The majority leader—and I am paraphrasing his
comments now—led us to believe that high interest rates cause inflation. He showed the chart with the usual gap at the ends of it.
On page 10 of your statement, Mr. Secretary, you basically say, and
I think the majority leader said this, that those of us who would
abandon this steady moderate growth of monetary reserves and
monetary supply, that they believe that faster money growth would
depress interest rates. And you say that history does not support
that view and you have an attached chart and so forth.
It seems to me in basic interpretation of both of those statements, that you and he take the same information and reach directly the opposite conclusions. Would you comment on that?
Secretary REGAN. Yes. Obviously we think we are right and we
think that from this chart that we have in there on interest rates
and inflation, you can definitely see that the inflation leads the interest rates. As far as the recent case has been that interest rates
have stayed up, even though inflation is coming down. This is a
very unusual phenomenon that has been apparent only in the last
couple of years.
Over history, the deficits have little bearing on interest rates. If
you want to track this, look at the growth in the monetary base.
You will see that chart following the money supply. That is what is
causing your rates to change. I think there is where you will see it.
Mr. PARRIS. I can only make the observation, I certainly share
your point of view, Mr. Secretary, although I admit to being slightly prejudiced in that regard.
Thank you. My time has expired.
The CHAIRMAN. Thank you, Mr. Parris. You know, a straight
remark here. It seems to me when the President presented the
budget, that large deficit, he said not to worry because it is such a
low percentage of GNP. Maybe I am wrong, but that is my
memory.
I think I am correct in that.
Secretary REGAN. Who said it, sir?
The CHAIRMAN. The President?
Secretary REGAN. I do not think he said not to worry. I think he
said we should all be concerned about it. However, it is less as a
percent of gross national product than in the 1974, 1975 recession.
No, he has been saying time and time again that deficits do
matter and we must get deficits down.
The CHAIRMAN. So that the people who have that psychological
blockout there, it is because of the high deficits, is that correct?
Secretary REGAN. They have to be convinced that we are going to
get the deficits down. They are not believing our $91 billion or now
$96 billion. What we are saying is that it is going to be even higher
than that, because the Congress would not enact all of the spending cuts that we have proposed and so on and so on and so forth.
The net result will be that there is a deficit out there somewhere
between $120 and $150 million; that is what has him worried.
The CHAIRMAN. I apologize, Mr. Vento. I just could not resist.
Mr. VENTO. Well, Mr. Chairman, Mr. Secretary, I appreciate you
coming over this morning so we can understand a little bit of this
economics. It is sort of like a dog-chasing-his-tail-around-a-tree discussion I am afraid.

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We will all be arguing about how we got here but last summer
there were some actions taken and it is my view and I expect not
yours, that they compounded whatever was in the mill. They compounded it. The problem is where are we going from here.
Unfortunately, I think that we have this big deficit which CBO
says is something like $120 billion if we adopt the President's policies. We are well aware of the proposed tax changes or increases
you proposed. We are not aware of the ones that you have not proposed. We feel some probably should be proposed in order to steer
this thing on a little steadier course.
One of the concerns I have is with your statement on page 2,
"Deficits are not good/' I guess we all agree with that. While no
one likes taxes, we think maybe there ought to be more discipline.
That is why I voted last summer for a tax bill offered by Mr. Udall
that was more modest than that offered by the administration.
I think we would have been better off if it had passed. You talk
about robbing the private sector of resources to do something. This
has been in effect for over a year now, in the form of the accelerated cost recovery portions and many other provisions of the tax
law. But I mean the fact is that all of the government spending in
terms of these programs was stimulative in some respects.
In other words, not all money that is spent by the National Government is sort of dumped in the ocean, is it? It does have and can
have a positive effect if it is utilized efficiently and properly, can it
not?
Secretary REGAN. But only about one-third as efficient as in the
private sector.
Mr. VENTO. I think it is important to look at that. But in looking
at some of the tax proposals, like now we are looking at enterprise
zones and a variety of other things, it reminds me of someone
trying to put a piece of plate glass in with a sledge hammer, in
terms of the cumbersomeness of some of the provisions.
We look at various stimulative things. You look at what the costs
of those are in terms of the successful programs we have, I become
very upset. The leasing provision. Your estimates have been exceeded in that, whatever the merits are—and I do not see much
merit in it—you obviously see more based on last week's news reports with regard to that issue.
It seems like the costs of doing some of these items is far greater.
We agonized in this committee about providing loan guarantees for
Chrysler Corp., loan guarantees, Mr. Secretary. Yet there are billions of dollars that have gone off through tax changes with virtually no input, no public policy statement, 59 different changes in
taxes as had been itemized by one of my colleagues, and I suspect
that is correct.
I think we should really strive to eliminate those portions—we
never look at tax expenditures once cuts are made. And it has been
one of the fastest growing areas in terms of loss. For you to suggest
that that has nothing to do with the deficit, I think, does not further responsibility and discipline in this particular area.
We look to the administration to evoke some discipline. God
knows Congress has not had that under other administrations, I do
not think we have had it under this administration. I would hope
you would reel back in some of that ability, and try to guide these

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things and craft them a little more clean. I think you have a
chance here to make some improvements without necessarly extinguishing the flame that you proposed initially in your measures
last summer.
Secretary REGAN. Let me comment on several of those things.
First of all, enterprise zones, you will admit I think that there is a
problem with the inner cities, particularly the inner cities of the
East and the Central States. And this is an attempt to help them
out.
The budgetary effects, the tax effects of what we are proposing
there are less than a half a billion dollars. But a lot of this, we
think, will be very stimulative to getting people to go into the enterprise zones, to establish factories there, other types of endeavors
in order to raise employment there, particularly among blacks and
other minorities, in these inner cities where the unemployment
rate is running very high.
So I do not think that enterprise zones are going to be a, a
budget buster, and I think they will be a darn good thing for the
inner cities.
As far as leasing, that did not exceed pur projections. We projected there would probably be about $18 billion of leasing in the 1981
period. Our preliminary estimate is $19.3 billion. I think we are
pretty much on the mark as far as anticipating what the effect
would be.
That is not the budget effect, that is the total amount of leasing.
The budget effect is about $1,500,000,000, which is what we suspected it would be in 1981.
As far as tax expenditures are concerned, I have to disagree with
that word. We do not own people's money. And when we allow
them to keep their money through some type of interpretation of
the tax law, that is not an expenditure by the Federal Government.
It is allowing people to keep their own money. So I do take exception to that.
But in the category of loophole closings and other changes in the
tax code, we have proposed 13 billion dollars' worth of those. And
we think that is quite a lot. We also agreed to work at least with
the Senate Finance Committee—as yet Ways and Means has not
gotten to it—on the underground economy, to collect our moneys
that are probably due to us.
There are estimates that run as high as $95 billion that are due
to us in the underground economy which we never collect. So we
are going to try to go after that. Again I come back to deficits and
tax cuts. What I was referring to there, when I was talking, was
the individual tax cut, particularly that third year, and I said that
I did not think that that was monstrous, as the majority leader
characterized it.
I do not think that it is something that we should abandon, because it is going to create a higher deficit. If that is so, then you
are saying the man on the street is responsible for the deficit and
he better darn well pay up and get his share of the deficit down.
Mr. VENTO. The majority leader was talking about the total tax
package of 59 different cuts, not focusing on this individual one.
Secretary REGAN. The majority of those tax cuts were in the individual sector.

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Mr. VENTO. Some were, some were not. One of the things he
pointed out was the decrease for instance in corporate taxes from
an average 28 percent, from a high of about 40 at the beginning of
the 1960's, down to 14 percent. This decrease is probably partly due
to the recession, but largely due to the tax changes that have been
enacted. Plus, of course, there have been estimates that—and I
think the President's proposal for a minimum tax suggests—that
the corporate tax is effectively zero.
If you are so concerned about the individual, and feel inclined to
create these tax expenditures, which you are reluctant to call
them, perhaps you ought to be as concerned about loading the
entire tax burden on them. Indeed, some Senators are even proposing that social security taxes now, which have been exclusively
used for social security benefits, ought to make up for the deficits
that we have this year due to whatever reason.
I would submit to you that those may be some thoughts that
should be circulated within the administration in terms of their
concern about the individual, because I am going to tell you that
those are concerns that are being aptly expressed by the people
that I represent.
Secretary REGAN. I do not think people are talking about anything except the taxes that are being imposed upon them by the
Federal Government. I think that what they are saying is to cut
the spending so we do not have to be taxed as much. I think that is
exactly what is on their mind.
If you look at most polls, they are saying cut spending, do not tax
us as much. We are in sympathy with that. That is exactly what
we are saying. As far as the business cut is concerned, from the
point of view of our 10-5-3 and the like, that was exactly paralleled by the democrats last year in Ways and Means.
Mr. VENTO. Too bad I did not have an opportunity to vote against
that bill in there. But I think that if you could have offered some
discipline at that point, which other administrations have done
with regard to tax policy on the Hill, we would not have had something like that occur.
Secretary REGAN. Discipline, sir, in raising $250 billion in 4 years
from 1977 to 1982 and then overspending by $200 million. I do not
consider that discipline.
Mr. VENTO. The popular and easy thing to do is cut taxes. Congress has never had any trouble doing that in the past. With your
help they did just a wonderful job in terms of decimating the revenue system of this country and our ability to support the things
that are necessary, whether it is highways, defense, or whatever.
You have done a great job in taking the economy, which was on
its knees, and knocking it on its back. I sincerely hope that we can
work at this particular point to rectify what has happened. But I
do not see that attitude emanating from the administration.
Secretary REGAN. I would have to object, sir, to your characterization of a tax cut that did not go into effect until August as
having caused this recession that started in July.
The two simply do not go together. Second, I also have to say to
you that since we are going to collect this year, 20.3 percent of
gross national product in taxes, which except for 1981, is the high-

190

est share in over a decade, as a percent of gross national product,
that we have not knocked the tax system all to pieces.
I think that we are collecting too much right now.
Mr. VENTO. Next year you may be able to collect it all because
none of the businesses in my area, small, large, or individuals are
making any money because of the recession or depression.
Secretary REGAN. That has been brought on by high rates of interest.
Mr. VENTO. Like I said, Mr. Chairman, a dog chasing his tail
around a tree.
The CHAIRMAN. Dr. Paul.
Mr. PAUL. Thank you, Mr. Chairman. Welcome, Mr. Secretary.
I would like to follow up on the discussion on taxes, because I
think my view is slightly different from what we have heard so far
today. I would like to suggest that there could be an argument for
a real tax cut. I would like to get your comments on this proposal.
This year, it is estimated that our revenues could go up between
$20 and $25 billion. So as you have said, we have not had any real
tax cut.
I believe that we have only nullified a proposed $96 billion increase in taxes, and evidently those who decry the fact that this
nullification of a proposed tax increase has occurred would like to
raise taxes by $96 billion in the midst of a recession.
I think that would be a total disaster. It is amazing to me to hear
the people who have traditionally advocated tax cuts in periods of
recession now saying we should have tax increases. I would like to
suggest that we ought to really cut taxes for a change.
We had a severe depression in the 1930's. Some claim it ended
with the war. I do not accept that. I think taking 12 million men,
putting them in uniform, lowering the standard of living further,
and then killing 1 out of 20 does not end a depression. The depression ended after the war. After the war we cut spending by 75 percent over a 3-year period, we cut taxes in real terms by 37 percent.
Revenues went down by 37 percent between 1946 and 1949, and
the depression finally ended. I am suggesting that what we really
need to do is cut taxes. But, of course, it would be very nice if we
would also cut the spending. I am afraid that the problem is not
that politicians like to cut taxes. That is not a problem; that is a
great event.
The problem is when are they going to get the guts to cut the
spending? Would you go along with a program to really cut taxes?
I realize you are struggling to keep Congress from raising taxes,
but I would be delighted to see a real tax cut.
Secretary REGAN. That is why last year we supported indexing,
when it was suggested so that we would have a break on tax increases in the future. And hopefully, this would bring about the
balanced budget. I personally, although the administration has not
taken a position, favor a constitutional amendment if necessary in
order to get a balanced budget from this Congress and from this
administration or any administration in the future.
I think such a move is going to be necessary inasmuch as it does
not seem that we can accomplish balancing the budget in any other
fashion.

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Mr. PAUL. I have an additional question on a different subject
that has to do with the leading economic indicators. They are
coming out today and I want to refer to them.
Question 1, in particular, concerns the money supply figures.
When we read the money supply figures, whether we use the factor
of L or M2 in relationship to CPI, if the supply is going up, this is
interpreted by the Government as a positive sign. Yet the marketplace reads it differently.
If we have a sudden increase in the money supply, the market
certainly discounts this as a very negative factor. In the last several months we have had a $5 billion increase in M2 and the CPI has
been going up slowly, which according to the conventional interpretation of the indicators, is a very positive thing.
I do not think the market sees it as a positive thing. And besides,
if you have M2 and CPI increasing in a uniform way, this is read as
a neutral factor. If the money supply is going up at the same rate
as prices, this is completely neutral.
I would question whether or not maybe we should reassess the
interpretation of the money supply factors as leading economic indicators?
Secretary REGAN. I would agree with you. The money supply
does have an enormous effect on the leading indicators in a perverse way. I do not think that it absolutely characterizes what
should be a leading indicator of further economic growth. I think
that we probably have here a case of mistaken identity. I think
that it is something that literally economists should think through
in view of current circumstances as to what those leading indicators and lagging indicators are doing.
It is very peculiar, you know, what has happened in today's indicators. The leading indicators are down, and the lagging indicators
up, and that would indicate that we are in prosperous times and
sometime in the future we might be going to have a recession
which obviously is incorrect.
So I think you have to discount entirely these leading indicators.
Mr. PAUL. Who is in charge of determining which indicators are
to be used and what their interpretations are?
Secretary REGAN. They emanate out of the Commerce Department. The National Bureau of Economic Research works with the
Commerce Department in establishing the indicators.
Mr. PAUL. Thank you, Mr. Secretary. My time has expired.
The CHAIRMAN. Mr. Schumer.
Mr. SCHUMER. Thank you, Mr. Chairman. I appreciate your sitting here and waiting for us, the more junior members of the committee.
This junior member is puzzled, to say the least, by some of the
economic figures that your administration is standing by. It seems
to me that these figures are almost hallucinogenic. I wondered who
was doing what when you came up with these figures. How can it
be that in the 1983 budget the administration projects 5 percent
GNP growth, a budget deficit of $96 billion, and still maintain that
Treasury bills will be sold at 10.5 percent.
Can you name one person outside of the administration who
thinks those predictions are consistent in any kind of economic

192

framework? Can you find one person who thinks Treasury bills are
going to be sold at 10.5 percent?
That is why Wall Street is worried. I have talked to Wall Street
people, too. They do not believe your predictions. No one else does
either, whether they be from the right, the left, or the middle. We
are not being fooled. I would like an answer on your 10.5 percent
Treasury bill rate prediction. Do you really believe in your heart of
hearts that fiscal 1983 Treasury bills are going to be sold at 10.5?
Secretary REGAN. We sold T bills last year at about 10 percent,
in spite of the fact that starting out the year we had an inflation
rate of 12.5 percent. We had a prime interest rate of 21.5 percent.
Mr. SCHUMER. What are you selling them at now?
Secretary REGAN. About 14.25.
Mr. SCHUMER. And you think
Secretary REGAN. Two weeks ago they were 13. The T bill rate
can move very fast.
Mr. SCHUMER. Do you really believe it is going to be sold at 10.5
percent? When you look at the mirror while you are shaving do
you say that we will have T bills sold at 10.5 percent by September?
Secretary REGAN. If you guarantee that Congress goes along with
the deficit in the 1980's and produces these tax decreases and
budget cuts that we have asked for and gives us a budget, which so
far the Congress has not done, but gives us a budget
Mr. SCHUMER. The President's budget you are talking about.
Secretary REGAN. Anything closely approximating that range of
deficit. If you will do that, T bills will sell at 10.5 percent.
Mr. SCHUMER. We are being very conundrumic. First we are hallucinogenic, now we are conundrumic.
Secretary REGAN. You asked how we came up with these figures.
I am explaining how. We assumed Congress would do this. If you
are telling me Congress will not do it, we will have to go back and
change our estimates.
Mr. SCHUMER. If Congress does enact the Reagan budget, and
God forbid that from happening in the way that it has been proposed, there will not be a budget deficit of $96.5 billion according to
every single person I have spoken to who does not wear the mantle
of the administration.
Whether they be conservative, moderate, liberal, Communist,
Fascist, nobody on Earth thinks that if this budget is enacted, we
will have a deficit of $96 billion. So when you say to me if we enact
this budget we will, you are standing alone. You are at the Alamo.
Secretary REGAN. I do not talk to Communists and Fascists. But
others that I talk to indicate that they do not believe the Congress
will give us our budget.
Mr. SCHUMER. That is not the issue. The issue is
Secreatry REGAN. That is the issue because ours was focused on
the fact that we sent up our budget. Based upon that we said T
bills would sell at 10.5 percent.
Mr. SCHUMER. I have asked people if the deficit will be $96.5 billion if Congress enacts the Reagan budget just as proposed and if
they believe T bills will be sold at 10.5 percent. The answer is a
deafening no. Can you cite for me a well-known economist of any
repute who believes that? Outside of the administration?

193

Secretary REGAN. Alan Greenspan has said if the deficits are as
low as $110 billion, that interest rates will be down sharply and he
is projecting
Mr. SCHUMER. I know he said that.
Secretary REGAN. He is projecting at least 3 percentage points
down.
Mr. SCHUMER. I beg your indulgence
Secretary REGAN. You asked for a well-known person who would
say this.
Mr. SCHUMER. He said that if the deficit was $110 billion, interest rates would go down. What I am asking is, Who has said that if
the administration budget is enacted, the deficit will be that low? I
have not found anybody.
Secretary REGAN. Alan Greenspan for one. Wait a minute, sir, he
talked to me. After all he does report to me in his capacity as one
of the heads of the Economic Advisers, and he said
Mr. SCHUMER. That moots my point. I asked for someone outside
of the administration. But OK. I have one other question and that
is just a viewpoint I would like you to respond to.
Secretary REGAN. For the record, I would like to find such a
name and put it in the record.
[Secretary Regan subsequently submitted the following additional informantion for inclusion in the record:]
RESPONSE RECEIVED FROM SECRETARY REGAN
According to the New York Times, the fiscal year 1983 deficit in the President's
budget was estimated to be $95 billion by Irwin Kellner of Manufacturers Hanover
Trust, and $90 to $100 billion by John Wilson of Bank of America.

Mr. SCHUMER. I would very much appreciate that. The one other
question I have deals with the issue of fairness. Let us assume that
we all think the budget should be cut, and accept as an axiom that
taxes should not be increased more than the $13 billion you have
proposed. If we accept these conditions then all of the cuts have to
come on the spending side. I want to ask you your judgment. Do
you think in the name of fairness, the American people do not and
my constituents do not, that we should cut student loans and mass
transit and medicare in the amount we have cut and leave synfuels, water projects, agricultural subsidies, virtually uncut as was
proposed in this budget?
Secretary REGAN. Well I
Mr. SCHUMER. My point is this: My constituents who benefit from
the first set of programs, not from the second, are willing to take a
share of their cuts. But right now, unlike last year, there is a feeling that those cuts are slanted and unfair and geared at keeping a
political constituency together rather than administering the economic medicine that we need.
I would like your comment.
Secretary REGAN. First of all, let's take a look at student loans. I
had occasion last week to make a speech at a major college and in
preparation for that speech I looked into it. As I understand in
fiscal year 1983 the budget provides more than $2 million in total
tuition support. That is $1.5 billion less than in 1982, but three
times the level available in 1977. This means that there are 7 mil-

194

lion loans, scholarships, or grants available for college students in
the United States.
There is a college population of 11 million. That means that
more than one out of every two of all of the students in the United
States has the opportunity for assistance under our proposal. In addition to that, of course, there are State grants, State aid, of various types, plus private.
So that the cuts that everyone is fearing here, and are yelling
about, are not of that dimension. We have not gutted the program
when more than one out of two of the students has the opportunity
for Federal aid. I have checked this out with several universities as
to what percentage of their students are now getting Federal aid.
Some run roughly around two-thirds. Some are about 50 percent.
Mr. SCHUMER. The figure, for instance, under the administration
proposal is $30,000. I do not know if that squares with the twothirds but you will agree with me that it is hard for a family
making $31,000 to send a student to a private university without
any student aid?
Secretary REGAN. There are numerable private types of help
available through private institutions for such students who are
not getting Federal aid and who need more aid. Now, as far as the
fairness is concerned, I am not a real authority on agriculture or
water resources.
So I would have to say that for the record, I will go back and get
you an answer. Right now, I could not comment in that area.
Mr. SCHUMER. I am sorry, Mr. Chairman
The CHAIRMAN. You are overtime.
Mr. SCHUMER. I will continue the dialog in writing, if you will.
Secretary REGAN. I think I would enjoy that.
Mr. SCHUMER. I do not know if I would.
[In regard to the above colloquy with Congressman Schumer, the
following additional information was received from Secretary
Regan for inclusion in the record:]
RESPONSE RECEIVED FROM SECRETARY REGAN
I agree with the President's statement in his Budget Message, that the Administration's deficit reduction plan addresses each area of the budget where actions to
reduce the deficit are possible and desirable. The new proposals will have no adverse impact on our economic recovery program, are fair and equitable, and will
contribute significantly to the reduction of future deficits.

The CHAIRMAN. Mr. Weber.
Mr. WEBER. I am going to pass this time.
The CHAIRMAN. Thank you, Mr. Weber.
Mr. Patman.
Mr. PATMAN. Mr. Secretary, does the administration accept any
of the blame for the deficits that have occurred?
Secretary REGAN. Well, I would say yes. Because inflation came
down and to a certain extent we are responsible for inflation
coming down but there were other factors.
So to the extent that over $60 billion of the deficit is now caused
by the reduction of inflation, sure we are responsible for it.
Mr. PATMAN. That is the only part that you accept?
Secretary REGAN. Yes, because everything else we have been
trying to cut back on.

195

Mr. PARRIS. How much of last year's tax cuts are currently being
financed by borrowed money?
Secretary REGAN. I have no idea, sir. How much of last year's tax
cut is being financed by borrowed money? I know that the deficit is
being financed entirely by borrowed money. But I am not sure that
I could give you that percentage.
Mr. PATMAN. Would you say the deficit was caused in part by the
tax cuts last year?
Secretary REGAN. No. And I will tell you why. There was only a
1 Vi-percent tax cut last year, for individuals who make up roughly
60 percent or more of tax collections and that barely kept—in fact
did not keep pace with inflation, so we actually took more from the
average taxpayer last year than otherwise.
Mr. PATMAN. Are you telling the committee that a tight money
policy results in lower interest rates?
Secretary REGAN. Yes. That is correct.
Mr. PATMAN. When you were with Merrill Lynch, did you pay
close attention to interest rates then?
Secretary REGAN. Certainly.
Mr. PATMAN. When you heard the Fed was going to embark on a
tight money policy, did you conclude that you were going to have
lower interest rates?
Secretary REGAN. That usually followed. Except in the 1960's, it
did not follow in the 1960's. It changed during the 1970's and in the
1980's.
Mr. PATMAN. Did the average Joe on the street get the tax break
last year?
Secretary REGAN. I beg your pardon?
Mr. PATMAN. Did the average Joe on the street get the tax cut
last year?
Secretary REGAN. He got 1% percent, yes.
Mr. PATMAN. Of the total tax expenditure or tax cut, the lower
estimates that we anticipate in revenues, what percentage was
given to the average Joe on the street?
Secretary REGAN. I have no idea. We would have to figure that
out for the record. I will come back to you on that.
Mr. PATMAN. Actually, it certainly was not the fellow that gets
less than $20,000 worth of income?
Secretary REGAN. He did not get too much of a tax cut, no.
Mr. PATMAN. $30,000?
Secretary REGAN. Once you get into that $30,000 to $50,000, you
are starting to get into where the majority of American's earnings
are and where the majority of taxes are collected, so your proportion goes up rather sharply in that area.
[In regard to the above colloquy Secretary Regan submitted the
following additional information for inclusion in the record:]
RESPONSE RECEIVED FROM SECRETARY REGAN
For 1981 taxpayers with annual income of $20,000 or less received about 16 percent of the tax tax (as they had about 16 percent of the tax liability) and those with
annual income of $30,000 or less received about 36 percent of the cut (they had
about 36 percent of the liability). Median income for a family of four is about
$25,000 per year.

196

Mr. PATMAN. You talked about the uncertainties in the market
and how they influence interest rates staying up. How does a
person react feeling an uncertainty of how interest rates will go
and how policies are going to go and withholding his funds from
the market and thereby causing inflation to rise or rather interest
rates to rise?
Secretary REGAN. From that point of view, what happens here is
that the average lender of money, whether it be an insurance company or bank or what have you, decides that there is no way that
they can make money just by loaning it out with 2 or 3 percent
over the inflationary rate. They are going to have to demand more
if they are uncertain as to what is going to happen to the supply of
money over the near term and indeed, what is going to happen to
inflation over the long term.
Mr. PATMAN. From whom does the insurance company and so
forth demand this higher rate?
Secretary REGAN. From all borrowers, business, individuals, and
the like. Although individuals borrowing on their life insurance
policies, as you know by contract, can get it at a lower rate of interest.
Mr. PATMAN. Are you telling us then that the interest rate really
is largely administered by people who decide what it is going to be?
Secretary REGAN. It is a decision of thousands, indeed millions of
people. But all are looking at more or less the same statistics.
Mr. PATMAN. What percentage and how few of them? What percentage of the rate, what percentage of the borrowing is influenced
by a small number? It is a difficult question but let's go into how it
impacts on the Treasury bill rate.
How does a person feeling uncertainty react about the rate of inflation?
Secretary REGAN. We put our bills out for auction and the dealers, both dealer banks and nondealer banks bid on them. We do not
know what goes into their forecasts except that they look at current rates of interest and put in some type of thought as to what is
going to happen over the near term if these are 91-day bills, as to
what they think will happen to the rate of interest over that period
of time and bid accordingly.
Mr. PATMAN. My time is expired; thank you, Mr. Secretary.
The CHAIRMAN. Mr. William Coyne.
Mr. W. COYNE. Last year when the economic recovery program
was proposed to Congress, we were told that enactment of the tax
cuts for the business community throughout the country would be
a stimulus to reinvestments and would create jobs and an upswing
would begin to happen.
Many people do not believe that has begun to happen. As late as
yesterday, David Roderick, chairman of the board of United States
Steel, said he just did not believe that the business community had
responded as predicted.
Would you care to comment on whether or not the business community has been responding as it should and as this administration
wanted it to?
Secretary REGAN. The response has not been as great as we
would have liked it. I think actually, in point of fact, what happened here is that business has been overtaken by the recession,

197

and the recession has gone deeper than most forecasters thought it
would.
The net result is that we have idle capacity, capacity utilizations
down in the low seventies 70, 72 percent, in that range. That is
hardly the type of thing that leads a businessman to think of building a new plant, particularly when he takes a look at the rates of
interest that would be charged him, long-term rates, for AAA
bonds now are in the 15.5-, 16-percent area.
You can hardly make the figures come out correctly to where
you show a good profit on 16 percent money. So I think that the
combination of high rates of interest, and the recession, have postponed most of these plans. I do not think they have killed them, I
think they just postponed them.
Mr. W. COYNE. On another subject that was raised earlier, it was
indicated that this administraton would like to take some credit for
the reduction in the inflation rate. But they are reluctant to take
responsibility for the high interest rates and the high unemployment rates, saying those were caused by prior administrations and
prior Congresses.
I just wonder at what point during the tenure of this administration we can get an answer that would say well, we indeed are responsible for the status of the economy?
Secretary REGAN. In answer to a similar question about 3
months ago in testimony I made a statement I will stick with
today, I said 1 year after our tax bill and our budget cuts went into
effect, that we should be held responsible. But particularly the tax
portion should have at least 1 year. That would mean August of
the coming year.
Mr. W. COYNE. But has not the business secton of the tax cuts,
has it not had more than a year to take effect? I mean, it was retroactive, wasn't it?
Secretary REGAN. That was retroactive to February as I recall,
and has been now in effect just about a year.
Mr. W. COYNE. So we will have to wait beyond a year, I guess?
Secretary REGAN. On the business portion as I previously discussed with you, I think that portion will come around as soon as
we get the interest rates down and as we emerge, as I think we will
in the second quarter, from the current recession.
Mr. W. COYNE. Thank you very much.
The CHAIRMAN. Mr. Secretary, one last question, if I may. In our
original discussion we discussed, I asked you a question as to your
prediction or projection on interest rates between now and September of this year, if the President's budget were to be adopted. Since
that is the only budget we have before us at this time.
Your answer was that you felt that there would be a sharp drop
in interest rates.
Secretary REGAN. That is correct, sir.
The CHAIRMAN. Now, for the benefit of the committee and
others, would you for us define what you look upon as a sharp drop
in interest rates?
Secretary REGAN. You will reall I prefaced that adverb by a
statement, Mr. Chairman, that for 35 years I have been ducking
the precision of that question. Again I will have to duck.

198

The CHAIRMAN. Mr. Secretary, please do not. Please do not. I
mean you parred that hole even though you shanked and went into
the rough.
Secretary REGAN. That was the Federal Reserve that shanked. I
never did.
The CHAIRMAN. I thought you were talking about yourself. Because you know, in the past you have told me about your acuity
and your silence on the links which probably would not be as good
when you finish your term as Secretary of Treasury, but I am sure
you will get it back again.
Please do not, this is a very serious important question.
Secretary REGAN. You recall that I said to Mr. Schumer in our
dialog that I believe that if our program is enacted, that there will
be a 10.5-percent T bill rate later this year. And I will stick on
that.
The CHAIRMAN. See, prime rate now
Secretary REGAN. Is right now 14.25 for T rates.
The CHAIRMAN. Prime rate, let's go to
Secretary REGAN. That would indicate the short-term rate is
coming down about 3 to 4 percentage points.
The CHAIRMAN. Three to four points on short-term rates. You
have answered my question. We thank you. And we appreciate
your appearance, your patience, and your waiting. I am sorry about
that, I apologize for that.
Thank you for a very stimulating session.
Secretary REGAN. Remember the conditions on the short-term
rate. That we must have the budget deficit down in the nineties.
The CHAIRMAN. Well, I prefaced the question with our accepting
the President's budget. And the President's budget has a built-in
deficit which originally was $91 billion.
Secretary REGAN. Let's make sure we are talking about the right
fiscal year, in fiscal 1982 our projection is $102 billion. Our projection for 1983 is $96 billion. On that premise.
The CHAIRMAN. All right. Again thank you.
Secretary REGAN. Thank you, Mr. Chairman.,
[Whereupon, at 1 p.m., the subcommittee was adjourned.]
[The following statement of Vere Vollmers of the Minnesota
Farmers Union, St. Paul, Minn., was submitted for inclusion in the
record:]

199
STATEMENT
OF
TORE VOLLMERS
VICE PRESIDENT
MINNESOTA FARMERS UNION
My name is Vere Vollmers.

My wife, Ellen, and I farm 800 acres

near Wheaton in west central Minnesota.

We have three children, two of

which are in school.
I would like to address my comments today to my farming operation,
to my rural community, and to the state of agricultural economy.
Traverse County, ray home county, has the highest percentage of
tillable land of any county in Minnesota.
land is tillable.

Ninety-three percent of the

Average farmland is available for sale today at

between $1000 to $1500 per acre.

Rental farmland can be leased at

approximately $65 per acre.
The town of Wheaton is a farming town of 2000 persons.
have manufacturing plants or assembly lines.

We don't

Our rural main street

businesses literally live and die according to the health of the farming
economy.

But, right now that economy is nearly dead.

Last year declining purchasing power by farmers forced a car dealership
to close its doors.

Rumors are that Traverse County is also about to

lose an implement dealer. Those are pretty dramatic changes for a
county with a population of only 6000 persons.
. The reason I mention my county and the town of Wheaton is simple:
the fact is that the business and the personal tax breaks advanced by
the Administration and approved by Congress last year will have almost
no impact on our local economy.

Unless the farm economy improves through

higher farm prices our rural community will continue to suffer.
Tax breaks are only good if you make enough money to qualify for
them.
In many ways my farming operation is different from my neighbors.
I am taking over my father's farm but I am doing it on more favorable
terms than most farmers in my county.

200
Even so, last year my gross income for 800 acres was $150 per acre.
My personal debt load at a bank or other lending institution is small in
comparison to most farming operations.

Consequently, my yearly interest

payments are also lower.
But let's suppose for a minute that some day soon I'll have to buy
out my brother's and sister's share of my father's farm.

And let's

suppose that I am able to buy the land at an average of $1000 per acre
and I am able to finance it at 17 percent interest at a local bank.
In this example, my interest payment on this additional land would
be $170 per acre per year.

To re-emphasize, $150 per acre was my gross

income for 800 acres in 1981.
I used this example to illustrate a point.
today who doesn't favor lower interest rates.

You won't find a farmer
But the farmers of America

are growing tired of hearing the Administration rejoice every time
interest rates decline by a fraction of one percent.

The reality is

that even if the prime interest rate declines to 14 percent, I can't
afford to buy more land and pay the interest payment with the cash
receipts from that land.
There have been many auction sales in Traverse County in the last
decade.
out.

It used to be the older farmers—the retiring farmers—who sold

Once upon a time, the young fanners would go to these sales and

literally get started in farming with auction sale machinery.
The auction sales in Traverse County had a new look this past year.
The older farmers are still selling out but so are the young ones.
young farm families in my community are giving up, selling out, and
moving off the land.

The

201
It is ray belief that most of the current sales are the result of
two primary reasons:
1,

These farmers expect no improvement in grain prices and farm
income during the next few years.
These farmers foresee no help coming from this Administration
to correct the crisis.

In 1981, I heard much rhetoric about the "safety net for farmers"
that would be part of the Administration's Farm Bill.

Let me remind you

that net farm income last year was $18.9 billion.
The Administration argued during debate on the farm bill that their
"safety net" would protect the declining farm income we had.
This year, however, net farm income is projected to be much lower
than last year

perhaps below $15 billion.

It is my conclusion that the Administration's safety net for last
year is not the same safety net being used this year.

If the safety net

really exists, then this Administration and Congress need to do something
quickly because $4 billion in farm income is about to slip through the
net.
The U.S.D.A. has acted on one front to encourage farmers to cut
back on production in the hopes that farm prices will improve.

At best,

the reduced acreage program is dismally poor and those within the U.S.D.A.
know it.

Even Sec. of Agriculture John Block has announced he will not

participate in the program....but he expects that other farmers will.
For the record, I intend to sign up for the program but I will
decide later on whether to participate.

As I see it, the reduced acreage

program will cost the government pennies in comparison to the income
dollars sacrificed by farmers.

202
What we need in American agriculture today is a farm program with
realistic loan levels for the major commodities.

I am not talking about

a nickle increase or a dime increase in loan levels.

We need levels at

least close to the cost of production.
Loan support levels are exactly what the term means.

They are

commodity loans to farmers - loans repaid with interest.
I do not come to this hearing today asking for a handout.
citizen of Traverse County are not asking for a handout either.

The
In our

county less than 1 percent of the farm families are on food stamps
though many families qualify.

Of the more than 6000 residents in our

county, records show that only an average of 2 families per month receive
general welfare.
So, as you can see, the spirit of helping others—the spirit of
volunteerism--is alive in my community.

The spirit of volunteerism is

alive in my family through the eyes of my two adopted daughters.
But not all the volunteers in the world can help the farm families
in my community who have their back to the wall.
agriculture needs help now.

The fact is American

The foreclosures and bankruptcies continue.

Young and old farmers are being driven off the land and the auction
sales continue.
Our farm economy is not moving ahead with our current economic
policy.

In fact, the agricultural economy has slipped greatly since

January 1981.
What has Reaganonomics meant to me?

It has meant higher school lunch prices for my children
and less variety for those meals at school.

203
The 1981 tax breaks have had no apparent impact on our
county economy. General Electric, as I have seen, greatly
benefitted from the tax breaks because they made huge
profits. The tax break of was little value to my family.
Reagonomics provided American farmers with a Farm Bill
that has the greatest spread between loan levels and the
cost of production in the history of federal farm programs.
If that is what Reaganomics is
nothing from it.
THANK YOU.

and nothing more

then I got

204

INTERNATIONAL UNION, UNITED AUTOMOBILE, AEROSPACE & AGRICULTURAL IMPLEMENT WORKERS OF AMERICA—UAW
DOUGLAS A. FRASER, PRESIDENT

RAY MAJERUS, SECRETARY-TREASURER

VICE-PRESIDENTS
DON EPHL1N

OWEN BIEBER

MARTIN GER8ER

ODESSA KOMER

MARC STEPP

April 5, 1982

ROBERT WHITE

STEPHEN YOKICH

IN REPLY REFER TO
1757 N STREET, N.W.
WASHINGTON, D.C. 20034
TELEPHONE: (202) 828-8500

The Honorable Fernand J. St. Germain, Chairman
Committee on Banking, Finance and Urban Affairs
U.S. House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
This is to convey to you and your committee the UAW's deep distress at the relentless
tight-credit course pursued by the Federal Reserve Board with the support of the
Administration. I request that this letter be inserted in the record of your hearings
of March 30, which regrettably I was unable to attend.
Though tight money and accompanying sky-high interest rates drove the entire economy
into recession starting in mid-1981, industries like auto which are so sensitive to credit
market conditions have borne the brunt of the monetarists' assault. While the economy
as a whole has been in recession for nine months auto has been deep in a depression for
36 months due to the combined effects of skyrocketing imports, an uncertain energy
outlook, and Volcker's relentless monetary grip.
In his letter of last July, UAW President Douglas A. Fraser gave you an account of
the crisis in the auto industry, and explained how that crisis has been severely aggravated
by the Federal Reserve Board's policies. Since then, the crisis has gotten even worse:
relative to the same period in 1981, 1982 domestic car and truck sales through March
31 were down 10%. Compared with early 1979, the industry's last healthy period, early
1982 sales of domestically produced cars and trucks were down 33%. Production in
the first quarter of 1982 barely exceeded 1 million cars, down 35% from 1981's already
depressed first quarter to the lowest level in 30 years. Capacity utilization in the
motor vehicle industry plunged to 43.6% in January and 47% in February, the lowest
figure on record for any industry since official publication of the statistical series began.
In the car assembly companies alone, over 250,000 workers are on indefinite layoff.
According to the Bureau of Labor Statistics, production worker employment in the
industry has declined by 40 percent since July 1979. Including the loss of supplier and
other auto-related manufacturing jobs, the decline in employment has exceeded 1 million.
The four domestic auto companies sustained a combined loss of $4.2 billion in 1980,
and lost another $1.3 billion in 1981. Many supplier companies have found themselves
in an even worse predicament: business failures among transportation equipment
companies rose from 38 in 1978 to 55 in 1979, 92 in 1980, and over 100 in 1981.

205
Dealers have closed their doors at an unprecedented rate. Between January 1979 and
September 1981, 2,864 dealerships went out of business, 12% of the total.
Not only auto, but other basic metalworking industries employing large numbers of
UAW members, have been hit by the Fed's iron fist. Sales of construction equipment,
which UAW members also build, have been pummelled by the slump in construction:
unit shipments were down 38 percent in the third quarter of 1981 from the first quarter
of 1979. Employment dropped apace: more than 21,000 workers — fully 18 percent of
the total workforce — have lost their jobs.
Tight credit has also hit the demand for farm equipment. Unit shipments fell 40
percent from the first quarter of 1979 to the third quarter of 1981, putting 20,000
workers (18 percent of the workforce) on the street. Compared with the same period
in 1979, sales of medium and heavy trucks in the first two months of 1982 were down
almost 50 percent. The manufacture of commercial aircraft •— another industry where
thousands of our members work — has also been hit, due to the plight of major airlines
caught in the squeeze between recession and tight money.
Beyond the direct impact of tight money, to the extent that high interest rates
contributed to an unwarranted surge in the value of the dollar in the recent past, there
has been a further depressing effect on domestic industries as imports have been
stimulated and U.S. exports have become less competitive in world markets.
Weak sales, excess capacity and the forbiddingly high cost of credit threaten to
permanently damage auto and other basic industries. As their investment plans are
postponed or permanently scaled back, their future competitiveness is at stake — and
so are the hundreds of thousands of jobs they provide.
While the viability of key industries is threatened, the entire economy is immersed in
what will doubtless become the worst recession since the Great Depression. The
unemployment rate now matches the May 1975 high with no end to its rise in sight;
business failures appear to have reached a 50-year peak; and the housing industry has
sunk to its lowest point since World War II. Productive investment has plummeted
across the board: as 30 percent of manufacturing capacity lies idle, business is cutting
back capital spending below last year's already depressed level.
In spite of two back-to-back quarters of 4.5 to 5 percent estimated annualized drop in
real GNP, interest rates remain at incredibly high levels, both in absolute and relative
terms. Short-term rates have dropped only 1.8 percentage poins from their recent peak
in the third quarter 1981, while the drop at a comparable stage in the three previous
recessions averaged 2.7 percentage points — from a substantially lower base. With the
recent decline in inflation, "real" interest rates are widely believed to be at the highest
level in the nation's history, reflecting the continued stringency of credit market
conditions.
With Administration support, the Fed maintains that it will continue to keep a tight
rein on credit until the record federal deficits projected for the next few years have
been reduced. This is Hoover economics at its worst; among the policies urgently
needed to combat today's severe and deepening recession are adequate fiscal stimulus
and adequate credit supply growth. Though we are deeply disturbed by important
aspects of the Administration's fiscal proposals — including the gutting of vital social
programs, the wasteful and dangerous military build-up, inequitable tax policies, and
the disastrous erosion of needed federal revenues in future years — one thing we do
not quarrel with is the need for fiscal stimulus now and into 1983 to help pull the

206
nation out of recession. If monetary stringency continues, however, fiscal stimulus
alone will not do the trick.
Responsibility for high interest rates and the pain and damage they are inflicting rest
squarely with the unconscionably tight credit policies that Chairman Volcker is still
adamantly pursuing -~ with the full support of the Administration.
While other policies are also badly needed, the economy will not get back on a path
of healthy and sustained growth until the monetary grip is relaxed, and the Federal
Reserve Board once again permits normal credit expansion.
Only under those
circumstances will hundreds of thousands of UAW and other workers be back on their jobs.
Sincerely,

Sheldon Friedman
Research Director
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