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SHADOW OPEN MARKET COMMITTEE
Policy Statement and Position Papers

March 7, 1977

1. Shadow Open Market Committee Policy Statement, March 7, 1977
2. SOMC Members – March 7, 1977
3. Position Papers




Projections for the Economy – Jerry L. Jordan, Pittsburgh National Bank
Comments on Fiscal Policy Developments – Thomas Mayer, University of California
Economic Policy in the Carter Administration – Allan H. Meltzer, Carnegie-Mellon University
International Economic Policy – Wilson Schmidt, Virginia Polytechnic Institute and State
University

Policy Statement
Shadow Open Market Committee
March 7, 1977
For the past several years the Administration and the Federal Reserve have pursued
policies jbhat fostered recovery, increased employment and reduced i n f l a t i o n .

The

economy is now closer to the long-term goal of high employment without i n f l a t i o n than
many believed possible a year or two ago.
Currently, statements by the Administration and actions of the Administration and the
Congress suggest that this approach has ended.

Emphasis appears to have shifted to

the system of p r i o r i t i e s and fine tuning based on the mistaken b e l i e f that policymakers can reduce unemployment without increasing i n f l a t i o n .

Fine tuning, whenever

i t has been t r i e d , has resulted in higher i n f l a t i o n and often higher unemployment.
At i t s meeting today, the Shadow Open Market Committee took note of some disquieting
policy proposals and actions.

These include (1) a package of stimulants to bring about

a short-term b l i p in employment and consumption, but l i t t l e encouragement to capital
formation — a crucial determinant of productivity increases that sustain long-term
growth of employment and standards of l i v i n g ; (2) proposed changes in taxes and in
minimum wages that increase unemployment and reduce incentives to work; (3) pressure
on foreign governments to i n f l a t e t h e i r economies in the hope of gaining support for
i n f l a t i o n a r y policies in the United States; (4) an increased growth rate of money,
currency and demand deposits that stimulates the economy now, but raises the rate of
i n f l a t i o n in future years.
W do not accept the view that capital formation can be encouraged only by stimulating
e
consumption expenditures.

Lagging investment is more l i k e l y to revive i f businessmen

can confidently look forward to an environment in which government d e f i c i t s do not
absorb $100-$150-billion of private sector savings in the next two years.
would then be available to finance expenditures on plant and equipment.




Real savings

-2It is misguided to attempt to stimulate consumption expenditures by expansive monetary
and fiscal policies in response to supply cutbacks in a period such as the extremely
cold winter of 1976-77.

Production of money is no cure for the shortfalls in the

production of goods.
If the proposal to raise minimum wages is adopted, this will lead to higher unemployment, particularly for new entrants into the labor force.

The result will be to

increase pressure on the Federal Reserve to increase the monetary growth rate and
ultimately to raise the inflation rate.
We should refrain from pressuring foreign governments to inflate their economies.

They

are better judges than we are of their own national interests.
A return to high employment without inflation will not be achieved by fine tuning the
economy.

It is doubtful that employment and output will be increased, on average,

during the next three to five years, by a policy of increasing employment now and
slowing inflation "later."

A lasting recovery with low inflation can be achieved if,

instead of fine tuning, we proceed gradually to achieve both goals; higher employment
and a stable price level.
The Committee recommends that the growth rate of money -- currency and demand deposits -be held in the range of 4 to 4-1/2% for the next year.

A 4 to 4-1/2% rate of monetary

growth would bring the stock of money to approximately $320-billion in the third quarter
1977 and to $326-billion in the first quarter 1978.

These projections are made from

the average $313-billion that would have prevailed in first quarter 1977 if our previous
recommendations had been followed.

Currently, we anticipate an average money stock

of $315-billion for the first quarter, so the policy we recommend requires the Federal
Reserve to offset the recent surge in money and then maintain a less inflationary policy.




-3The Choices Before Us
We recognize that the policy we recommend reduces the measured growth rate of money,
temporarily, by removing the recent bulge in money growth.

From 4th quarter 1976

to 4th quarter 1977, our proposal brings the growth of money to approximately 4-1/2%,
near the lower end of the Federal Reserve target for money, but is still far above
the rate ultimately required to achieve price stability.

The recommended rate of

growth is one percentage point lower than the growth rate endorsed by Chairman Reuss
of the House Banking Committee and more than thirty members of Congress.
A more rapid growth of money in the next few quarters might possibly lead to a temporary
increase in employment and real product.
The effects of higher monetary growth are not, however, limited to the response of output in 1977 or 1978.
inflation.

Increased monetary growth

raises

actual and anticipated

The increase in inflation is not immediately apparent but would become

apparent in 1978 and 1979.

Once again, we would be faced with the choice we had in

1966, 1969, 1974 and in the intervening years -- to accept more inflation or to shift
"priorities'1 from reducing unemployment to reducing inflation.
posts —

Guidelines and guide-

under old or new names -- will neither reduce inflation nor change the out-

come.
The choice before us is to trade a short-term increase in employment for higher longterm inflation, or to gradually but steadily move toward high employment without inflation.
The Administration and much of the Congress appear to have chosen a course that will lead
to higher inflation.

The Federal Reserve flirts with the prospect of supporting the

policy by increasing the rate of monetary growth.
The rate of monetary expansion consistent with high employment and stable prices is in
the neighborhood of 2% per year.




Higher rates of monetary expansion move

us away from

-4our long-term goals and increase

the difficulty of restoring full employment and

ending inflation.

SHADOW OPEN MARKET COMMITTEE MEMBERS
Prof. Karl Brunner, Director of the Center for Research in Government Policy and
Business, Graduate School of Management, University of Rochester, Rochester, NY
Prof. Allan H. Meltzer, Graduate School of Industrial Administration, CarnegieMellon University, Pittsburgh, Pa.
Mr. H. Erich Heinemann, Morgan Stanley & Company, Inc., New York, N.Y.
Dr. Homer Jones, retired senior Vice President and Director of Research, Federal Reserve
Bank of St. Louis, St. Louis, Mo.
Dr. Jerry Jordan, Vice President and Chief Economist, Pittsburgh National Bank,
Pittsburgh, Pa.
Prof. Thomas Mayer, University of California at Davis, Calif.
Prof. A. James Meigs, Dept. of Economics, Claremont Men's College, Claremont, Calif.
Prof. Wilson Schmidt, Dept. of Economics, Virginia Polytechnic Institute, Blacksburg, Va.
Dr. Beryl Sprinkel, Senior Vice President and Economist, Harris Trust and Savings Bank,
Chicago, 111.
Dr. Anna Schwartz, National Bureau of Economic Research, New York, N.Y.
Dr. William Wolman, Senior Editor, BUSINESS WEEK, New York, N.Y.




February 2, 1977

Page

ECONOMIC OUTLOOK
(BILLIONS OF DOLLARS--SFASONALLT ADJUSTFP ANNUAL tfATES)
FORECAST

ACTUAL

Years

—TZTT —TfTT

'
CROSS NATL PRODUCT
ICH
CONSTANT DOLLAR C I P

1

ZH
C

fTTT"

—rrrr —rrrr

1748.5
9.4

1788.0
9.3

1845.0
13.4

1281.5
3.0

1295.7
4.5

1319.7
7.6

73: I

78: 2

78:3

75

78:4

76

77

.

78

1893.4
10.8

1943.0
11.0

1991.0
10.3

2041.0
10.4

2092.0
10.4

2144.0 1
10.3

1516.3
7.3

1692.4
11.6

1867.2
10.3

2067.^
10. >

1335.9
5.0

1351.2
4.6

1365.6
4.3

1380.9
4.6

1394.7

1406.8 1

'U9i.7
-1.8

1265.0
6.2

1325.6

1387.0

4.8

4.6

1.4083
5.3

1.4900
5.8

4.0

3.5

1.3644
6.2

1.3800
4.7

1.3980
5.3

1.4170
5.5

1.4380
6.1

1.4580
5.7

1.4780
5.6

1.5000
6.1

1.5240
6.6

1.2721
9.2

1.3377
5.2

1117.5
11.1

1144.3
9.9

1176.2

1207.3

1234.7

1264.2

11.6

11.0

9.4

9.9

1294.9
10.1

1327.4
10.4

1358.6
9.7

973.2
9.7

1078.6
10.8

1 190.6
10.4

1311.3
10.1

DURABLES
ZCH

161 . 2
9.5

165.3
10.6

174.5
24.1

180.4
14.2

185.0
10.6

190.5
12.4

196.2

201.8
11.9

206.6
9.9

131.7

156.3

176.3

198.8

12.5

8.3

18.7

12.8

12.7

NONOURABLES
ZCH

455.5
13.0

467.6
11.1

478.0
9.2

491 . 0
11.3

501 . 0
8.4

512.5
9.5

524 . 3
9.5

536.9
10.0

549. 2
9.5

409.1
8.7

440.3
7.6

484 . 4
10.0

530.7
9.6

SERVICES

500.8
9.9

511.4
8.7

523.7
10.0

535.9
9.6

548.7
9.9

561.2
9.4

574.4
9.7

588.7 •
10.3

602.8
9.9

432.4
11.0

482.0
11.5

529.9
9.9

581 . 8
9.8

249.0

254.2.

. 241.2
31.3

276.0
14.5

320.4
16.1

PRICE DEFLATOR
ZCH

CONSUMPTION EXPEIDXTUftES
'

I

ZCH

XH
C

1 INVESTMENT EXPENDITURES
ZH
C
NONRES FIXED EXPEKD
ZCH
PRODUCERS DUt EQUIP
ZCH

\

BUSINESS
ZCH

STRUCTURES

RES FIXED EXPEND
ZCH
INVENTORY CHAMC*
NET EXPORTS

271.6

284.0

333.6

1B3.7

30.3

19.6

304.2
14.0

327.6

8.6

294.4
15.5

316.1

3.3

16.6

15.A

7.5

-14.5

165.5
6.3

171.2
14.5

177.6
15.8

184.0
15.2

191.0
16.1

198.0
15.5

204.5
13.8

211.0
13.3

217.3

147.2

207.7

-1 . 4

160.0
8.7

180.9

12.5j

13.1

14.8

108.0
3.8

111.0
11.6

115.0
15.2

119.0
14.7

123.5
16. Q

128.0
15.4

132.0
13.1

136.0
12.7

140.0
12.3

95.1
-0.0

104.5
9.9

117.1
12.0

134.0
14.4

57.5
11.2

60.2
20.1

62.6
16.9

65.0
16.2

67.5
16.3

70.0
15.7

7:.5
15.1

75.0
14.5

77.3
12.8

52.0
-3.8

55.4
6.4

63.8
15.2

73.7
15.5

75.6
44.9

79.0
19.2

83.0
21.8

87.0
20.7

90.0
14.5

92.0
9.2

93.0
4.4

94.0
4.4

95.0
4.3

51.2
-7.0

67.8
32.4

84.7
25.0

93.5
10.3

7.9

4.0

11.0

13.0

13.4

14.2

18.6

22.6

21.3

-14.6

13.5

10.4

19.2

5.2

4.0

3.0

1.0

1.0

0.0

0.0

0.0

0.0

20.5

6.9

2.3

0.0

400.5

413.0

422.5

13.J

9.5

437.0
6.7

452.ol

6.8

430.0
7.3

339.0
11. 8

365.7
7.9

398.1
8.9

435.4
9.4

155.0

1 5 7 .O

1 5 9 .O
5.2

167.0!
21.7

124.4

131.4

US J

9.6

5.3
103.0

108.0

100.0

101.5

6.3

8.9

394.0
9.7

138.9
13.7

141.0
6.2

143.5
7.3

145.0
4.2

151.5
19.2

MILITARY

91.3

92.5

94.0

95.0

98.5

OTHER

47.6

48.5

49.5

50.0

53.0

COVT PURCHASES

ICH
FEDERAL
ZCH

STATE A LOCAL

ZH
C

376.9

238.0
5.2

385.0

244.0
10.5

250.5
11.I

255.5
8.2

261.5
9.7

NOTE: PERCENTAGE C&ABCES AT ANNUAL RATES; PRELIMINARY DATA FOR




1

76:4

56.0
55.0
267.5
9.3

55.5 •
273.O
8.5

278.0
7.5

14.5'

59.0
285.ol
10.5

.

11 .A

84.3

40.1
214.5
12.0

7.2.

88.2
45.2
232.3
a.3

a .9

103.1

95.0

56.4

50.3
252.9
8.8

275.9
9.1

Bamtmmmmmmmm^mmmmmammmm^mtMmmmtm

PACE 2

E C O N O M : C OcTLOOK
( B I L L I O N S OF DOLLARS — SFASO»»ALLY ADJUSTED ANNUAL RATES)

FORECAST

ACTUAL
76:4
PRETAX
ZCH

PROFITS*

157.4
20.6

Years
7 7:1

TTTT

160.6 •
8.4

168.1
20.0

___

77:4

78: I

78 : 2

78:3

175.7
19.3

179.1
8.0

184.8
13.4

189.6
10.8

193.7
8.9

78.s
198.3]
9.8

75

77

7T~

114.5
-10.2

148.7
29.8

170.9
14.9

194.6
12.1

A9.3
-6.1

64.6
31.1

72.3
12.0

80.5

65.3
-13.1

84.1
28.9

98.5
17.1

lll.l
12.8

TAX L I A B I L I T Y
ZCH

68.3
21.2

69.7
8.4

70.6
5.3

73.8
19.3

75.2
8.0

77.6
13.4

79.6
10.8

81.4
8.9

AFTER TAX PROFITS
ZCH

89.1
20.1

90.9
8.4

97.5
32.4

101.9
19.3

103.9
8.0

107.2
13.4

110.0
10.8

112.3
8.9

52.688
-26.5

59.900
67.0

63.498
26.3

65.906
16.1

65.878
-0.2

66.184
1.9

66.968
4.8

67.346
2.3

68.01'
4.C

42.375
30.8

54.047
27.5

63.795
18.0

67.128
5.2

1422.1
10.8

1457.0
10.2

1500.0
12.3

1538.0
10. 5

1578.0
1 0.8

1617.0
10.3

1657.0
10. 3

1698.0
10.3

1740.0
10.3

1249.7
8.4

1375.3
10. 1

1518.2
10.4

1675.0
10.5

205.3
20.9

212.3
14.3

186.2
-40.8

225.5
1 15.1

233.5
15.0

237.3
6.6

245.3
14.2

253.5
14.1

261 . 9
13.9

168.8
-0.9

193.6
14.7

214.4
10.7

249.5
16.4

1216.9
9.3

1244.7
9.5

1313.8
24.1

1312.5
-0.4

1344.5
10. 1

1379.7
10.9

1411.7
9.6

1444.5
9.6

1478.1
.
9.6

1080.8
10.0

1181.8
9.3

1303.9
10.3

1428.5
9.6

1144.0
11.1

1170.2
9.5

1202.5
11.5

1234.0
10.9

1261.8
9.3

1291.7
9.8

1322.8

1355.7

1387.31

996.9

1 lot .0 1217.1

1339.4

10.0

10.3

9.7

9.5

10.7

10.2

10.0

72.9
-14.4

74.5
9.2

111.3
398.0

78.5
-75.2

82.7
23.2

88.0
28.3

88.9
4.2

88.8
-0.4

90.8
9.3

84.0
16.3

77.8
-7.4

86.8
11.6

89.2
2.8

AFT TAX PROF ADjD
ZCH
PEKSONAL INCOME
XCH
TAX 4 HONTAX fATMENT
ZCH
DISPOSABLE

INCOME

ZCH
PERSONAL OUTLAYS
ZCH
PERSONAL
ZCH
SAVING

SAVINGS

RATE(Z)

83.3
9.8
115.01
9.8

6.0

6.0

8.5

6.0

6.2

6.4

6.3

6.2

6.1

7.8

6.6

6.6

6.2

EMPLOYMENT
ZCH

88.085
0.8

88.600
2.4

89.300
3.2

89.800
2.3

90.400
2.7

90.900
2.2

91.400
2.2

91.900
2.2

92.400
2.2

84.784
-1.4

87.480
3.2

89.525
2.3

91.650
2.4

LABOR FORCE
ZCH

95.717
1.6

96.000
1.2

96.500
2.1

97.000
2.1

97.400
1.7

97.900
2.1

98.300
1.6

98.700
1.6

99.100!
1.6

92.652
1.7

94.789
2.3

96.725
2.0

98.500
1 .8

8.5

7.7

7.4

7.0

DSEHPLOYHENT R A T E ( Z )

8.0

7.7

7.5

7.4

7.2

7.2

7.0

6.9

14.548
2. 1

14.624
2. 1

14.779
4.3

14.877
2.7

14.947
1.9

15.023
2.1

15.109
2.3

15.176
1.8

1 5 . 2 25
1 .3

14.054
-0.5

14.460
2.9

14.806
2.4

15.133
2.2

INDUSTRIAL PRODUCTION
ZCH

1.317
2.4

1.325
2.5

1.372
15.0

1.404
9.7

1.422
5.2

1.438
4.6

1.454
4.5

1.469
4.2

1.479J
2.8l

1.178
-8.9

1.298
10.1

1.381
6.4

1.460
5.7

MONEY
ZCH

310.5
6.2

315.8
7.0

321.2
7.0

327.0
7.4

333.0
7.5

339.0
7.4

345.0
7.5

351.5
7.7

358.0
7.6

289.5
4.2

304.0
5.0

324.3
6.7

348.4
7.4

VELOCITY OF Ml
XC>

5.631
3.0

5.649
1 .3

5.721
5.2

5.771
3.6

5.817
3.2

5.856
2.7

5.899
3.0

5.935
2.5

5.972
2.5j

5.236
2.9

5.567
6.3

5.740
3.1

5.915
3.1

MONE f
ZCH

732.5
12.7

752.0
11.1

772.0
1I.1

791 . 0
10.2

81 1 . 0
10.5

831 . 0
10.2

852.0
10.5

874 . 0
• 10.7

896.0
10.5

641 . 0
7.7

703.8
9.6

781.5
1 1.0

863.2
10.5

2.387

2.378
-1.6

2.390

2.393

2.396

2.396

2.396

2.394

0.4

0.0

-O.i

-0.3

2.365
-0.4

2.389
-0.7

2.394

0.5

2.393
-0.1

2.405

2.1

PRODUCTIVITY*
ZCH

SUPPLY-(Ml)

SUPPLY-(H2)

VELOCITY OF M2
ZCH

-3.0

6.8

NOTE:
PROFITS FOR 76.4 ARE ESTIMATES; PRODUCTIVITY IS CALCULATED AS CONSTANT DOLLAR GNP PER WORKER
I AFT-R TAX PROFITS ADJUSTED TO E.-I'JDE INVENTORY PROFITS AND ALLOW FOR DEPRECIATION AT REPLACEMENT
)




1.7

0.2

ECONOMIC

OUTLOOK

PACE 3

ACTUAL
Years
76:4
IITEREST

77:1

77:2

77:3

77:4

78: 1

78:2

78:3

78:4

75

76

77

78

RATES

SliP C O M ? . AAA BONDS

8.080

8.000

8.200

8.300

8.400

8.600

8.700

8.800

9.000

8.635

'8.358

8.225

8.775

NEW

7.850

8.200

8.400

8.600

8.800

9.000

9.200

9.300

9.500

8.910

8.250

8.500

9.250

6.83

6.81

8.00

ISSUE AA INDUS BONDS

6.51

PRIME R A T E
COMMERCIAL

PAPER 4 - 6 H T S .

6.25

6.50

7.00

7.50

7.75

8.00

8.00

8.25

7.86

4.99

5.25

5.75

6.25

6.75

7.00

7.25

7.75

8.00

6.32

5.35

6.00

7.50

8.7

11.3

9.9

9.9

10.6

11.3

11.3

11.3

11.3

11.3

10.I

10.8

DOMESTIC

8.3

8.4

9.1

9.6

9.7

9.7

9.6

9.6

9.6

7. 1

8.6

9.2

9.6

IMPOSTS

1.6

1.5

1.5

1.6

1.6

1.6

1.7

1.7

1.7

1.6

1.5

1.6

1.7

1.750.1.900

1.900

1.850

1.800

1.750

1.700

AUTO SALES

l)

BOUSIHC STARTS l)

1.823

. 11.2

0 IN MILLIONS OF UNITS—SEASONALLY ADJUSTED ANSCAL RATES
2> IM I I U I O R S OF DOLLARS
SEASONALLY A D J U S T E D AWKUAL RATES




1.650

1.163

1.561

1.850

1.725




PROTECTIONS FOR THE ECONOMY
Prepared for t h e
SHADOW OPEN MARKET COMMITTEE MEETING
March 7, 197 7

By
JERRY L. JORDAN
Sr. Vice President & Economist
Pittsburgh National Bank
Pittsburgh, PA

SHADOW OPEN MARKET COMMITTEE
M

Terry L. Tordan

PHONE NO.

412-355-3101

JECT ECONOMIC PROTECTIONS

1)

DATE

_ March 1, 1977

The accompanying projections assume t h a t t h e narrowly defined money
s t o c k (Ml) will g r o w near t h e upper end of t h e current Federal Reserve
r a n g e , but that i s not intended here to b e a recommendation nor a preference.

2)

Real output g r o w t h in 1977 will be stronger t h a n the final three q u a r t e r s
of 1 9 7 6 even w i t h M l growth at the l o w e r - e n d of the Federal Reserve
r a n g e , i.e. - 4 . 5 % .

3)

G r o w t h of v e l o c i t y (VI) is projected a b o v e t r e n d because of the lagged
e f f e c t s of a c c e l e r a t e d money growth in Q 4 / 7 6 and Q l / 7 7 .

4)

If t h e s e projections are a c c u r a t e , the " g a p " between a c t u a l real output
and "potential o u t p u t " will be e s s e n t i a l l y eliminated by l a t e 1977 or
e a r l y 1978, and r e a l output growth must s l o w to the 3 t o 3.5% r a n g e to
a v o i d accelerating inflation a s s o c i a t e d w i t h excess demand.

JLJ
JLJ/Ip
Enclosures




PROTECTIONS FOR 1977
(all figures annual r a t e s of change)

M

M

Actual_
Q4/75 - Q4/76

5.5

10.9

4.1

-0.9

1975 - 1 9 7 6

5.0

9.8

6.2

+1.6

Q4/76 - Q4/77

6.0

9.0

4.0

1.2

1976 - 1 9 7 7

6.0

9.9

3.6

Pro£ected_

-

GNP

Real
Output

Price
Deflator

9.8

5.0

4.6

1975 - 1976

11.6

6.1

5.1

Q4/76 - Q4/77

10.3

5 .9

4.2

9.9

5.0

4.6

Actual_
0 4 / 7 5 - Q4/76

1976 - 1977




Note:

Real output g r o w t h in the f i n a l three
quarters of 1 9 7 6 was only a t a 3.6%
annual rate, s o growth in 1 9 7 7 to 5
to 6% r e p r e s e n t s a significant
acceleration

.02



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Comments on Fiscal Policy Developments f o r Shadow
Open Market Committee M e e t i n g , March 7. 1977
Thomas K a y e r
University of C a l i f o r n i a , Davis

At t h i s meeting we face a n e w problem w i t h regard t o
f i s c a l developments.

The e l e c t i o n results have made t h e

o f f i c i a l b u d g e t f o r e c a s t s o b s o l e t e , while t h e r e i s as y e t
o n l y l i m i t e d information a v a i l a b l e on the new b u d g e t .
T am w r i t i n g t h i s I do not yet h a v e a copy of

(As

President

C artcr's new budget recommendations, and have a v a i l a b l e
o n l y newspaper reports of i t so t h a t I a l a c k i n g c o n s i d m
e r able d e t a i l . ) Furthorn.ore, h i s

budget proposals are

l i k e l y t o b e amended by Congress.

Hence, t h i s r e p o r t

is

unusually sketchy and t e n t a t i v e .

Previous Developments
Table 1 shows recent t r e n d s

i n government e x p e n d i t u r e s ,

revenues and d e f i c i t s on an NIA b a s i s .

While r e v e n u e s

( i n current dollars) have i n c r e a s e d by IS p e r c e n t s i n c e 1974,
t o t a l expenditures have i n c r e a s e d by 30 percent so t h a t the
d e f i c i t r o s e from $11,5 b i l l i o n
1976,

i n 1974 to $ 5 8 . 3 b i l l i o n in

The increase in government expenditures has b e e n

s u b s t a n t i a l l y larger for t r a n s f e r

payments t o p e r s o n s (which

r o s e in t h i s period by 39.1 p e r c e n t ) than f o r e x p e n d i t u r e s on
goods and services which rose by




1.

19.5 percent.

In r e a l

t e r m s the l a t t e r i n c r e a s e d h a r d l y
T h e rapM r i s e

« t all, o n l y

1 .5 percent.

in t r n n s f e n and i lie? vt<ry much « l o w o r rl«G

in

real v x p # n d I turns on goodt* and

of

a trend commented on i n p r e v i o u s report* by Bob Rasche and

myself.

H o w e v e r , it

rscrvlcea Iw a

continuation

i s worth n o t i n g that t r a n s f e r s

to

a n d local g o v e r n m e n t s have i n c r e a s e by $16.3 b i l l i o n
t h i s period

(37 percent)!

payments,

e x p e n d i t u r e s on goods and s e r v i c e s

by state and

least
induced

local

and hence l e a d t o a f e d e r a l l y i n d u c e d d e c l i n e

t h e p r o p o r t i o n of CNP a v a i l a b l e
To

should

s i n c e at

some e x t e n t they r e p r e s e n t i n c r e a s e s in f e d e r a l l y

governments,

in

These g r a n t - i n - a i d payments

n o t be t h o u g h t of as pure t r a n s f e r *
to

state

some e x t e n t

f o r private

at l e a s t t h e y a r e

in

expenditures*

a. s u b s t i t u t e f o r d i r e c t

federal

e x p e n d i t u r e s on goods and s e r v i c e s «

I t may t h e r e f o r e

to

e x p e n d i t u r e s o n goods

look a l s o

a t the t o t a l of f e d e r a l

a n d services plus t r a n s f e r s to s t a t e
F o r 1976 t h i s t o t a l i s 8 . 3 p e r c e n t
2 4 . 5 p e r c e n t above i t s

1974

figures differ

in calendar

1975 l e v e l

problems a s s o c i a t e d
1 9 7 5 and 1976 •

from t h o s e shown i n

n o t on an NIA b a s i s . )
quarter of

above i t s

governments.
and

level.

Table 2 shows t h e f i n a n c i n g
t h e Federal d e f i c i t

and l o c a l

be u s e f u l

As Table 2

1976, the off-budget

with

(The

deficit

Table 1 s i n c e Tatole 2 i s
shows, e x c e p t

i n -the

agencies plus the

F i n a n c i n g Bank added t o t h e d e f i c i t

last

Federal

t o be f i n a n c e d ,

as did,

o v e r the p e r i o d as a whole t h e T r e a s u r y ' s n e e d t o b u i l d up
c a s h balances.
of

In t h e l a s t t h r e e

minor m i s c e l l a n e o u s i t e m s a l s o




2.

quarters o f

197^,

a

added to t h e v o l u m e

number
of

financing needed.

As a r e s u l t t h e

borrowed f r o m t h e p u b l i c

Federal Government

( i n c l u d i n g t h e Federal

$ 6 8 . 9 b i l l i o n compared t o $ 8 5 . 5

in

Fiscal

Reserve)

1975«

1977

Table 3 compares t h e f o r e c a s t s for the c u r r e n t
y e a r of t h e

Ford b u d g e t , t h e CBO and the C a r t e r

budget.

Assuming t h e c o n t i n u a t i o n of c u r r e n t tax r a t e s t h e
ence
is

in t h e d e f i c i t f o r e c a s t b y t h e Ford b u d g e t

trivial,

t u r e increase.

due both t o a p r o p o s e d tax c u t

and t h e CBO

and an e x p e n d i -

Moreover, t h e C a r t e r budget m a k e s a somewhat

assumption about t h e g r o w t h of the t a x

It i s ,

differ-

w h i l e t h e C a r t e r b u d g e t shows a c o n s i d e r a b l y

larger d e f i c i t

different

fiscal

base.

however, g u i t e p o s s i b l e that the d e f i c i t wij.1

substantially

from t h a t p r o p o s e d

i n the C a r t e r b u d g e t .

o n e hand C o n g r e s s i s l i k e l y t o a d d a d d i t i o n a l
a n d perhaps c u t t a x e s

On t h e

expenditures

further.

But, on the o t h e r hand, n o t

a l l the i n c r e a s e i n

d i t u r e s p r o p o s e d e i t h e r by t h e A d m i n i s t r a t i o n
may a c t u a l l y occur.

differ

or b y C o n g r e s s

The Admini s t r a t i o n may s i m p l y

a b l e t o g e a r up e x p e n d i t u r e s f a s t
c u l a r l y s o i f Congress adds some

enough,

expen-

(This i s

n o t be
parti-

unwanted e x p e n d i t u r e

programs about which t h e A d m i n i s t r a t i o n i s u n e n t h u s i a s t i c . )
We have h a d one r e c e n t e x p e r i e n c e of how u n r e l i a b l e
t h e o u t l a y p r o j e c t i o n s of t h e b u d g e t can b e j
n i n e months of 1976 n e t o u t l a y s
estimates •




3.

in t h e

w e r e $11.4 b i l l i o n

a guide
fir*t
below

Furthermore, the Carter e s t i m a t e may, of c o u r s e , be
in

error d u e t o mistakes in p r e d i c t i n g the tften future path

of

income a n d prices - t h e r e a r e ,

months r e m a i n i n g in t h i s f i s c a l

a f t e r all, a b o u t seven more

year.

Currently i t i s par-

t i c u l a r l y d i f f i c u l t t o p r o j e c t i n c o m e and p r i c e s

because

of

recent cold

the d i f f i c u l t y of a s s e s s i n g t h e

impact of t h e

w a v e in t h e e a s t , the spring f l o o d s which w i l l
o c c u r in t h e east and t h e w e s t e r n drought.

probably

I h a v e , of course,

n o way of knowing in which d i r e c t i o n the i n e v i t a b l e
w i l l go,.

errors

Hence the p r e d i c t e d d e f i c i t for the c u r r e n t

fiscal

y e a r has t o be treated as an u n u s u a l l y u n r e l i a b l e f i g u r e .
I n this connection i t may be u s e f u l to repeat my warning from
o u r last m e e t i n g that i f one a s s u m e s that the Fed p i c k s
u p at the margin a quarter of any deficit and a l s o , a money
m u l t i p l i e r of 2, then an $8 b i l l i o n increase i n the
i m p l i e s a one percent increase i n

the Mj growth

deficit

rate.

Longer Run P r o j e c t i o n s
Table 4 shows the economic assumptions u n d e r l y i n g the
F i s c a l 1977"-as well as t h e l o n g e r
a r e two CBO p r o j e c t i o n s .

run budget p r o j e c t i o n s •

There

One r e p r e s e n t s the CBO's l o n g e r

r u n e s t i m a t e , and the other the m o s t recent r e v i s i o n of the
1977 e s t i m a t e s .

I t i s very hard t o make a c h o i c e among the

various p r o j e c t i o n s of Table 4 .

I t seems t o me, however, t h a t

t h e long run C O p r o j e c t i o n s of unemployment d e c r e a s i n g below
B
6 percent in calendar 1978 and t o 4.1 percent in 19^2 i s
much too o p t i m i s t i c *




The v a r i o u s projections of t h e

4-

inflation

r a t e are almost impossible to e v a l u a t e ,

T e i n f l a t i o n rate
h

experienced i n 1982 w i l l depend l a r g e l y upon what monetary
p o l i c y is followed until then, and,

given the Federal

Reserve's willingness t o tolerate w i d e fluctuations in the
monetary growth rate i t i s hard t o 55ee h w one can project with
o
any degree of assurance, p a r t i c u l a r l y at a time when i t
seem;* that t h e Federal Reserve i s returning p a r t of the way
t o a money market conditions approach.
Table 5 shows the projected budget trends which, for
t h e Carter budget are unfortunately

available only for f i s c a l

1977 and 1978 •

i t shows very substan-

For these two years

t i a l deficits t o t a l l i n g $125.7 b i l l i o n compared to a combined
d e f i c i t of $109.2 b i l l i o n in f i s c a l

1975 and 1976.

For the

f o u r fiscal years 1975-197*9 the tot«ul deficit i s therefore
projected at $235 b i l l i o n !

Tt i s a l s o worth n o t i n g t h a t the

projected d e f i c i t in the Carter budget for f i s c a l 1977 i s
p r a c t i c a l l y the same as for f i s c a l

1976 which was considered

an extraordinarily large d e f i c i t .
For the subsequent years the budgets show surpluses.
But these surplus projections for t h e far out years indeed
a r e "far out. 11
of

They are meant merely to indicate the amount

fiscal s l a c k , and nobody imagines that the federal govern-

ment will actually run a surplus o f $70 b i l l i o n or more in 1982.
Our past experience suggests that f i s c a l slack i s spoken for
before i t appears,and hence the s p o c i a l needs that w i l l
a r i s e in 1982 may well result in a deficit i n that y e a r .




5-

Other Federal

Financing

T a d d i t i o n to t h e unified b u d g e t the d e f i c i t s of u
n
number of off-budget
if

agencies h a v e t o be financed*

one wants t o measure the impact of federally

Moreover,

induced

financing o n e should a l s o look a t t h e deficits o f the governm e n t sponsored agencies and at t h e
government c r e d i t a g e n c i e s ,

lending a c t i v i t i e s of

I do n o t have any e s t i m a t e s of

t h e s e financing requirements in t h e
not

Carter budget

yet h a v i n g an actual copy of t h e budget.

available,

B u t , t h e Ford

b u d g e t s l i s t s these t o t a l s as f o l l o w s :

F i s c a l Year

Off-Budget
Federal E n t i t i e s
( b i l l i o n s of
dollars)

Government
Sponsored
Enterprises
( b i l l i o n s of
dollars)

N e t Loans
Guarenteed
( p i l l i o n s of
dollars)

1976

7.2

4.6

10.3

TQ

1.8

2.3

-

1 9 7 7 (est.)

10.8

11.0

1 1.3

1 9 7 8 (est.)

9.2

13.2

21.2

1 9 7 9 (est.>

10.0

N.A.

N.A.

Source:

.1

Iil£. Budget of t h e United S t a t e s Government
Fi;seal Y oar
<
[Tp p . ; 26& 3X.

OKIJ>

jm

In the Carter budget the d e f i c i t of the o f f - b u d g e t
a g e n c i e s in 1978 i s estimated at s l i g h t l y l e s s $8*5 b i l l i o n .
T h e s e figures while well below t h e d . e f i c i t of t h e

unified

b u d g e t of t h e l a s t two y e a r s , are b y no means s m a l l when
compared t o t h e more usual l e v e l o f




6.

deficits.

The u n i f i e d

budget therefore
c r o w d i n g out

i»* not a s u f f i c i e n t ,

guide to t h e

amount o f

o f t o t a l l y p r i v a t e f i n a n c i n g that c a n

Moreover, the d e f i c i t s o f o f f - b u d g e t federal
and

government: sponsored e n t e r p r i s e s

a danger t h a t they w i l l c o n t i n u e

pressures,

entities,

as well a s n e t

g u a r a n t e e s h a v e a l l grown very r a p i d l y
is

occur,

loan

since 1 9 7 6 ,

t o do so.

And t h e r e

With

political

b o t h t o b a l a n c e t h e b u d g e t and to i n c r e a s e

e m p l o y m e n t - g e n e r a t i n g e x p e n d i t u r e s w h i l e keeping t a x e s down,
t h e r e i s an o b v i o u s t e m p t a t i o n t o u s e
And

programs such as d e v e l o p i n g n e w

l i k e l y to p r o v i d e a Mjustification,f
of

such b a c k d o o r

financing*

sources o f e n e r g y
for e x t e n s i v e

are

financing

this sort.

Pioaaciag the
The t o t a l

borrowing from t h e

Deficit
public (including t h e

F e d e r a l R e s e r v e ) t h a t w i l l be r e q u i r e d t o f i n a n c e
d e f i c i t i n t h e Carter budget p l u s t h e o f f - b u d g e t
substantial.

Here are t h e

FY 1976

T o t a l borrowing
f r o m the p u b l i c
Sources:




the
outlays i s

estimates:

Transition
FY 1977
Quarter
(est.)
( B i l l i o n s of d o l l a r s )

g

l g

/ 0

FY

*978
(est.)

6

g

OMB, S p e c i a l Analyse,** Budget o f t h e U n i t e d
S t a t e s T " F i s c a l Y e a r 197^, p » 4 2 .
Wall S t r e e t J o u r n a l » February 2 3 , 1977 •

7.

Thus t h e federal government w i l l impose a

substantial

burden on t h e capital and money markets. To b e sure, this
burden i s l e s s than t h a t imposed i n fiscal 1 9 7 6 , but from now
o n it is l i k e l y to c o i n c i d e with increased p r i v a t e demands
f o r credit,

and hence w i l l act m o r e as a burden.

b e enough t o produce a c r e d i t " c r u n c h , * and t o

Will

it

induce the

Federal R e s e r v e to i n c r e a s e the growth rate o f t h e money stock?
T h i s is o b v i o u s l y a major i s s u e f o r us, but t o
question would require e s t i m a t i n g

answer t h i s

t h e private demand for

c r e d i t , something T am i l l e q u i p e d to do.
Moreover, i t i s worth n o t i n g t h a t there e x i s t two f a c t o r s
t h a t might change the burden on t h e credit m a r k e t s .
is

the p o s s i b i l i t y t h a t f o r e i g n e r s

proportion o f the new debt.

One

w i l l pick up a s i g n i f i c a n t

A.J T\\blc 6 shows t h i s s o u r c e of

financing h a s been far from t r i v i a l in the p a s t .

But

it

i s very hard t o forecast s i n c e i t

depends on t h e f u t u r e course

of

United S t a t e s and abroad.

relative i n t e r e s t r a t e s in t h e
The second factor i s that t h e

t h e Administration's f o r e c a s t .
o f f by s e v e r a l b i l l i o n s *

Carter b u d g e t i s

only

T h i s forecast may w e l l be

As d i s c u s s e d above, Congress i s

l i k e l y t o add to expenditure p r o g r a m s , but on t h e o t h e r hand
t h e r e may w e l l be d e l a y s in a c t u a l l y getting e x p e n d i t u r e s going,
a n d also t h e economic f o r e c a s t u n d e r l y i n g t h e revenue and
o u t l a y p r o j e c t i o n s may be in e r r o r * .
All i n a l l , the f i s c a l o u t l o o k i s even harder t o pin
down t h i s t i m e than i t usually i s .




8.

Table 1
Federal Government
Receipts and Expenditures

Calendar Year

UZi

±m

im

Revenues

288.2

286.5

330.6

T o t a l Outlays.

299.7

357.8

388.9

Pvirchases of Goods and Services

111.6

124.4

133.4

Transfer Payments to Persons

114.3

145.8

159.0

3.2

3.1

3.2

Grants-In-Aid: S and L, Gov.

43.9

54.4

60.2

Net Interest Paid

20.9

23.5

27.5

5.2

6.5

5.6

-11.5

-71.2

-58.3

Transfer Payments to Foreigners

Subsidies - Surpluses of Gov, E n t e r p .
Surplus or Deficit (-)'
Federal Gov, Purchases of
G o o d s and S e r v i c e s i n 1972 $

Source:




Q
v:> J
'

1977 Economic R e p o r t

9.

O C ^ Q A T
v:>

o f the P r e s i d e n t ^

* '

y o

'

/

p j J . 189 & 271

Tabic 2
Financial Flows o f the
Federal Government 1975-1976
(Calendar Y e a r s )
1975

1st
Half

U.S.

1226
2nd
Ql
Q2
Q3
Half
(quarterly r a t e s )
( b i l l i o n s of d o l l a r s )

Q4

Budget:

Receipts
Outlays
Surplus or
Deficit (-)
Off—Budget Agencies
S u r p l u s or D e f i c i t (-)
Fed Financing Bank
Net Outlays

ML 4
171.5

139.5
184.5

66.9

43.6

81.8

76.2

89.6

91.5

94.5

99.0

-30.1

-45.1

-22.7

2.2

-12.7

-22.8

.8

.6

3.0

-4.7

-

.8

- .5

-3.4

-2.7

-3.3

.1

-2.6

-2.6

Budget D e f i c i t and Off-Budget
Agencies D e f i c i t
a n d Fed. F i n . Bank
-38.1

-48.6

-26.5

1.5

-14.7

-22.4

36.2

49.3

24.1

9.4

18.0

17.4

-3.0

. 1

•7

-8.6

-2.9

5.1

.9

1.7

-2,2

- .4

- .1

Financed By:
Borrowing from Public
Cash and Monetary
A s s e t s Decrease
o r Increase ( - )
Other 1

Source:

i.

5.0

-

-

Federal Reserve B u l l e t i n » Jan., 1977, p. A30, and
Unpublished data p r o v i d e d thorough t h e courtesy
of
the Federal Reserve System,

Includes public debt accrued i n t e r e s t , payable to t h e p u b l i c ,
deposit f u n d s , miscellaneous l i a b i l i t i e s ( i n c l u d i n g checks
outstanding) and a s s e t a c c o u n t s , Special Drawing R i g h t s , e t c .




10.

Table 3
Estimated Receipts, Outlays

Ford B u d g e t Current Tax
Law

a n d D e f i c i t s FY 1977

Ford B u d g e t
Including
Recommended
Tax C u t

(Billions o f
(1) R e c e i p t s

CBO.
Projectionsa

Carter
Budget

Dollars)

360.9

354.0

356.5

349.4

(2) O u t l a y s

4U.2

4U.2

407.1

417.4

(3) D e f i c i t ( - )

-50.3

-57.2

-50.6

-68.0

(4) ^ e r . i c i * of
Off-budget
Federal
Entities

-10.P

-10.8

N.A.

N.A.

-61.1

-68.0

-61.4b

N.A.

(5)

(3)+(4)

Sources:

0MB, The Budget of t h e U n i t e d States G o v e r n m e n t T F i s c a l
1 9 7 8 , p p . 3,9 & 2 6 .
_ _ _
CBO, F i v e Year Budget P r o j e c t i o n s . F i s c a l Y e a r s
1 9 7 8 - 1 9 8 2 , p. 7 .
'
1977 C o n g r e s s i o n a l Budget S c o r e k e c p i n g R e p o r t #5_» PP« 3 & 10.
Wall S t r e e t J o u r n a l , F e b r u a r y 2 3 . 1977.
New Y o r k Times, February 2 3 , 1977.

a. S e c o n d c o n c u r r e n t r e s o l u t i o n on t h e
b . D e f i c i t o f Off-Budget




budget.

a g e n c i e s t a k e n as $10.8

H.

billion.

Table 4
Assumptions Underlying Budget P r o j e c t i o n s

1976

1977

1978
1979
1980
( c a l e n d a r years)

1981

1982

1693

1880

2092

2334

2579

2784

2963

CBO

a

1698

1884

2085

2304

2547

2809

3103

CBO

b

1692

1854

N.A.

N.A.

N.A.

N.A.

N.A.

6.2

5.2

5.1

5.9

5.5

3-9

3.5

CBO

a

6.4

5.4

5.6

4.7

4.5

CBO

6.4

4.3

N.A.

5.5
N.A.

5.3

b

N.A.

N.A.

N.A.

6.J

5.4

5.4

N.A.

N.A.

N.A.

N.A.

7.7

7.3

6.6

5.7

4.9

4.8

4.7

CBO

a

7.6

6.8

5.9

5.3

4.8

4.4

4.1

CBO

b

7.7

7.7

N.A.

N.A.

N.A.

N.A.

N.A.

7.6

7.1

6.3

N.A.

N.A.

N.A.

N.A.

G P Current $
N
(billion)
Ford

Budget

G r o w t h Rate o f
R e a l GNP (%)
Ford

Budget

C a r t e r P.ud&et

UneiupXoyment R a t e (%)
Ford

Budget

Carter
C.P.I.

Budget

Increase

if)
5.7

5.1

5.4

5.0

4.6

3.8

2.9

CBO

a

5.7

5.0

4.8

4.8

5.0

5.3

5.8

CBO

b

5.7

5.0

N.A.

N.A.

N.A.

N.A.

N.A.

5.7

5.1

5.4

N.A.

N.A.

N.A.

N.A.

Ford

Budget

C a r t e r Budget

b a s e l i n e assumption

b . February 10 Revision of estimates
c . Y e a r over y e a r




12.

Table
Sources:




OMB,
Year
CBO,
p. 4 .
1977
Wall

4

(cont.)

The Budget o f t h e U n i t e d States Government 9 F i s c a l
1978, p p . 4 1 - 4 2 .
~
""
Five Year Budget P r o j e c t i o n s ; F i s c a l Y e a r s 1 9 7 8 - 1 9 8 2 .
C o n g r e s s i o n a l Dudget. Scorekeeping R e p o r t //5» p . 2 .
S t r e e t J o u r n a l , F e b r u a r y 23. 1*977.

13.

Table 5
P r o j e c t i o n s o f Feder a l Budget T o t a l s

JL2ZI

!2Z£

13*1

1982

584.6

634.8

594.0
N.A.

668.0
N.A.

531.5
516.0

564.8
542.0

548.0

586.0

N.A.

1979
•1222
( Fiscal years)

N.A.

( b i l l ± o n s of ' d o l l a r s )
Receipts;
a

360.9

407.6

465.0

CBO b
C a r t e r Budget

356.5

407.0

464.0

526.4
526.0

349.4

401.7

N.A.

N.A.

411.2

445.4
445.0

427.7
467.0

502.1

45KO
459.4

480.0
N.A.

514.0
N.A.

-50.3
-50.6

-37.8
-38.0

-7.7
-3.0

24.3
35.0

53.0

-50.6

-44.0
-57.7

12.0
N.A.

46.O

-68.0

-16.0
N.A.

Ford Budget

Outlays
Ford Budget

a

CBO

413.1
407.1

b

CBO
C a r t e r Budget

417.4

S u r p l u 3 or D e f i c i t
Ford Budget

a

CBO
b

CBO
C a r t e r Budget
a.

(-)

a s s u m e s r e j e c t i o n of p r o p o s e d t a x

b. assumes f u r t h e r
Sources:




0MB,
Year
CB0«
p.7*
1977
Wall

491.0

adjustments f o r

a n d expenditure

78.0
N.A.

70.0
126.0
82.0
N.A.

changes

inFlation

The Budget of t h e U n i t e d S t a t e s Government F i s c a l
1978, p " 9 .
F i v e Year Budget P r o j e c t i o n s F i s c a l Y e a r s 1 9 7 8 - 1 9 8 2 ,
C o n g r e s s i o n a l Budget S c o r e k e e p i n g R e p o r t # 5 f PP* 3 & 10,
Street Journals Feb. 23, 1977.

14-

Table 6
Borrowing From F o r e i g n a n d I n t e r n a t i o n a l

Sources

Fiscal
Years

Total Borrowing
from P u b l i c a
( b i l l i o n s of $ )

Borrowing From
from Foreign &
International
Sources
( b i l l i o n s of $ )

1971

11.6

17.9

154.3

1972

13.5

17.3

128.1

1973

15.5

10.2

65.8

1974

-2.5

-2.5

100.0

1975

46.5

9.1

19.6

1976

73.2

3.8

5.2

TQ

16.0

4.8

30.0

Bbreign
Borrowing
(percent of
total)

a. i n c l u d e s f o r e i g n sources but e x c l u d e s Federal R e s e r v e

Source:




OKR, S p e c i a l A n a l y s e s B u d g e t of the U n i t e d
Government F i s c a l Year 1 9 / & , P*43.

15.

States




Economic P o l i c y in the Cairter Administration

Testimony prepared for t h e H o u s e Budget Committee
Washington,
March 3 ,

D. C.
1977

by
Allan H. M e l t z e r
Maurice Falk P r o f e s s o x of Economics
and S o c i a l S c i e n c e
Carnegie-Mellon

University

Draft
February 1977
Economic P o l i c y in the C a r t e r Administration
by
Allan H. M e l t z e r
A new a d m i n i s t r a t i o n , a new C o n g r e s s and a new c o r p s of economic
advisers i s

commonly t h e occasion t o reconsider the s t r a t e g y for the f u t u r e ,

t h e s u c c e s s e s and f a i l u r e s of the p a s t ,
current a c t i o n s .

and the l o n g - t e r m consequences of

Early impressions a r e subject to r e v i s i o n , in much the

same way t h a t economic s t a t i s t i c s a r e r e v i s e d , and I hope t h a t my e a r l y
impression o f Carter a d m i n i s t r a t i o n p o l i c i e s will be a s i n c o r r e c t as the
forecasts o f

those who found r e a l m e a n i n g in the s o - c a l l e d "pause" l a s t

fall.
The f i r s t

signs a r e d i s q u i e t i n g , tiowever, to anyone who b e l i e v e s that

t h e proper g o a l s of p o l i c y for the U n i t e d States are t o return to f u l l
employment, eliminate i n f l a t i o n , i m p r o v e efficiency i n t h e use of r e s o u r c e s ,
and increase freedom.

These goals c a n n o t be achieved by programs that p l a c e

o n e o b j e c t i v e — employment — above a l l others or t h a t s t r i v e to achieve
more employment now and reduce i n f l a t i o n "later."

Freedom and e f f i c i e n c y

a r e reduced, and sustained i n f l a t i o n i s unaffected by g u i d e l i n e s for price
and wage i n c r e a s e s .

Whether t h e s e g u i d e l i n e s are mandatory or whether they

a r e called "voluntary, 11 t h e i r p r i n c i p a l result i s t o d i v e r t t h e a t t e n t i o n
o f the p u b l i c by offering a comic o p e i r a for their l e i s u r e and a waste of
t h e time o f

those who enforce c o n t r o l s

and those who respond t o the e n f o r c e r s .

G u i d e l i n e s and c o n t r o l s are n o t t h e only r e s t r i c t i o n o n freedom and
efficiency.

The emergency energy p r o g r a m , the f i r s t economic

passed t h i s year, is heavy with t h e s u g g e s t i o n that i t

legislation

i s more important to

i n v e s t i g a t e the ownership of n a t u r a l g a s inventories than t o encourage




L

efficient production o f additional s u p p l y .

Once a g a i n , we have acted in

c r i s i s to i n c r e a s e t h e authority and power of the government over economic
a c t i v i t y , exchanging freedom and an e f f i c i e n t s o l u t i o n f o r some temporary
r e l i e f from t h e cold.
Government controls and r e g u l a t i o n s created a s h o r t a g e of natural gas
and prevented a rational s o l u t i o n t o t h e shortage*

The government uses the

c r i s i s to j u s t i f y an i n c r e a s e in i t s power and a u t h o r i t y to a l l o c a t e supply
and coerce s u p p l i e r s .

The fact t h a t t h e grant of power i s temporary

neither t h e grant of authority nor t h e

justifies

failure to c h o o s e a r a t i o n a l s o l u t i c :.

The a d m i n i s t r a t i o n ' s f i s c a l p r o g r a m also developed in disregard of freedom
and e f f i c i e n c y .

The presumption u n d e r l y i n g the program i s the simple

Keynesian v i e w that n e g l e c t s a l l e f f e c t s on i n c e n t i v e s , p r i c e s and a n t i c i p a tions.

What matters for consumption i s the amount consumers r e c e i v e ; what

matters f o r

investment i s the a d d i t i o n a l amount consumers spend.

Thoughtful

investors and consumers who p r o j e c t a f t e r tax rates o f r e t u r n b e f o r e deciding
t o invest c o u l d be encouraged by permanent tax r e d u c t i o n , o r i n other ways,
but they a r e not.

Indeed, they c a n n o t for long be encouraged by the f i s c a l

prospects t h a t we f a c e .
The f i s c a l program n e g l e c t s f r e e d o m and e f f i c i e n c y , a l s o , by protect'': £
the bureaucracy and future budgets f r o m reductions t h a t would increase the
efficiency w i t h which s o c i e t y uses r e s o u r c e s and the freedom of
t o decide o n how they wish to spend t h e i r incomes.

individuals

The l o n g - r u n thrust of

the Carter program i s to balance t h e government budget o n l y , i f a t a l l ,
b y increasing tax r a t e s through i n f l a t i o n , not by reducing the growth of
public o u t l a y s or the r e l a t i v e s i z e o f




government.

3

In t h r e e respects, t h e f i s c a l program is a s t r o n g reminder of some
past p o l i c i e s .
tuning.

F i r s t , once again, w& are to know t h e arrogance of

fine

Second, we a r e offered a n o t h e r piece of l e g i s l a t i o n designed by

the A s s o c i a t i o n for t h e P r o t e c t i o n o f
to the f a i l e d policy of " p r i o r i t i e s "

the Civil S e r v i c e .

Third, we return

that promises l o w e r unemployment now

and less i n f l a t i o n l a t e r but p r o d u c e s

instead a temporary g a i n i n employ-

ment f o l l o w e d by more i n f l a t i o n and m o r e unemployment l a t e r .

I propose to

discuss t h e short- and long-term e f f o c t s of the a d m i n i s t r a t i o n ' s program
in turn a n d to offer an a l t e r n a t i v e .
The Short-Term Problem
The f i s c a l program i s based on t w o errors.
other i s a conceptual error with s e v e r a l facets.
judgmental

issue quickly s i n c e i t i s

One i s judgmental; the
Let me d i s p o s e of the

rapidly becoming c l e a r that the

much d i s c u s s e d slowdown in the economy was misinterpreted by Keynesians
eager to b e l i e v e t h a t , because government spending i n the t h i r d quarter
f e l l b e l o w projections, the economy p a u s e d .
If we look at t h e quarterly r a t e s of change of g r o s s n a t i o n a l product
in 1976, t h e expansion reaches a peak: rate of change i n t h e f i r s t quarter,
then slows

for the r e s t of the y e a r .

exactly t h e opposite p a t t e r n .

Rates

The growth of f i n a l

s a l e s shows

of change of f i n a l s a l e s in d o l l a r s

of constant purchasing power are l o w e s t in the f i r s t q u a r t e r and h i g h e s t
at the end of the y e a r .
the r e s u l t

The d i f f e r e n c e between the two s e r i e s i s e n t i r e l y

of business d e c i s i o n s t o

f i r s t build and t h e n r e d u c e i n v e n t o r i e s .

There i s a simple, p l a u s i b l e e x p l a n a t i o n of the p a t t e r n of inventory
change.




A t the beginning of 1976, t h e b e l i e f was w i d e s p r e a d that the

u.
administration and t h e Federal R e s e r v e would produce enough stimulus to
assist i n

the e l e c t i o n of Gerald F o r d .

stimulus i n e l e c t i o n years i s p a r t o f
business c y c l e .

Excessive f i s c a l or monetary
the pattern known as the p o l i t i c a l

E l e c t i o n year 1964 brought a tax c u t #

E l e c t i o n s in 1968

and 1972 brought a mixture of e x p a n s ± v e fiscal and monetary p o l i c i e s .
Election y e a r 1976 was widely e x p e c t e d to bring more o f the same.
In t h e first months of 1976, b u s i n e s s e s b u i l t i n v e n t o r i e s i n a n t i c i p a tion of r a p i d l y r i s i n g s a l e s and t h e
expected t o follow.

higher rates of i n f l a t i o n they

By the end o f t h e first quarter, a n t i c i p a t i o n s of

another p o l i t i c a l b u s i n e s s c y c l e w e r e confirmed.
that would benefit t h e incumbents p a s s e d .
made t h e headlines.

The time for stimulus

Vetos of spending programs

Inventories w e r e brought i n t o c l o s e r r e l a t i o n to

sales.
T h i s interpretation of 1976 s u g g e s t s that a d d i t i o n a l stimulus i s
neither required nor d e s i r a b l e .

T h e economy does n o t require a f i s c a l

program t o stimulate spending and c r e a t e jobs.

The weakness of the economy

was o v e r s t a t e d during the e l e c t i o n campaign; current s t r e n g t h i s misjudged.
E r r o r s in forecasting are n o t s o rare that we should dwell on thanu

T

percentage points o r more i s about t l i e average error i n q u a r t e r l y forecas -r
of the r a t e of change of r e a l GNP a n d the price l e v e l in recent y e a r s .
The more serious problem a r i s e s

from the type o f a c t i o n proposed.

The f i s c a l program appears to be b a s e d on a b e l i e f t h a t economists can
achieve more output now without i n c r e a s i n g the rate o f i n f l a t i o n .

This

is to be done by timing the i n j e c t i o x i s of stimulus and r e s t r a i n t so as to
bring i d l e resources into u s e .




The

c r i t i c a l underlying assumption i s

5
t h a t , b o t t l e n e c k s a s i d e , larger s u p p l i o s of output can be produced without
raising t h e

rate of p r i c e change.

E v e n avid proponents of

additional

stimulus r e c o g n i z e t h a t the stimulus mxist be reduced when t h e economy
approaches f u l l employment.

We have returned to f i n e

Instead of general p o l i c i e s t h a t

tuning.

provide r e l a t i v e l y c l e a r

indications

o f the t h r u s t to be e x e r t e d by government programs, p r i v a t e d e c i s i o n makers
face i n c r e a s e d uncertainty.

To make p l a n s , they must g u e s s a t the type of

tax s t r u c t u r e and the length of time ^reductions i n unemployment insurance
taxes or i n c r e a s e s i n investment t a x c r e d i t s will remain i n e f f e c t .

To

estimate f u t u r e s a l e s , they must g u e s s at the s i z e and d u r a t i o n of the e f f e c t
of the r e b a t e .
Behind the f i s c a l package l i e s t t i e belief that e c o n o m i s t s can p r e d i c t
the effect

o f various mixes of s t i m u l ± with s u f f i c i e n t accuracy to provide

a choice t o policymakers.

The a l t e r n a t i v e of p r o v i d i n g a more s t a b l e

fiscal environment i s r e j e c t e d .

This

too, is a r e t u r n to f i n e tuning.

9

I

do not know any evidence to support t h e belief that e c o n o m i s t s can p r e d i c t
the s h o r t - t e r m aggregate e f f e c t s o f s p e c i f i c tax c u t s w i t h
accuracy t o justify t h e p o l i c i e s t h a t
Long-Term

sufficient

are now proposed.
Effects

Choice of a one-time rebate i n s t e a d of general t a x r e d u c t i o n i s a way
of maintaining future tax c o l l e c t i o n s .

President C a r t e r has promised a

balanced b u d g e t for f i s c a l year 1 9 8 1 , and permanent t a x r e d u c t i o n would
permit t h a t promise t o be kept o n l y ±f
rate of i n f l a t i o n r i s e s .

S p e c u l a t i o n on whether the a d m i n i s t r a t i o n can

achieve a balanced budget for f i s c a l




the growth of government f a l l s or the

1981 generally i g n o r e s t h e e f f e c t s of

6

inflation*

Since the tax system i s n o t indexed, a balanced budget can be

achieved b y allowing i n f l a t i o n t o
In

rise.

F i v e Year Budget P r o j e c t i o n s : Fiscal Years 1978-82, the Congressional

Budget O f f i c e shows the extent t o wh±ch inflation i s required t o balance the
budget i n

1981 or 1982.

Much of t h e ± r analysis i s based on an e x p l i c i t

assumption that the unemployment r a t e can be brought t o 4% by 1982 i f
growth i s

real

maintained in t h e neighborhood of 5-1/2% f o r the next four y e a r s .

The p o l i c y of vigorous expansion a d d s to inflation s o t h a t by 1982, the i n f l a tion r a t e

i s back to the 1976 l e v e l .

Many economists in and out o f government regard the p r o j e c t e d 4% unemployment r a t e as achievable only t e m p o r a r i l y and at the c o s t of r i s i n g
Several c a r e f u l s t u d i e s of the l a b o r

inflation.

force show t h a t a f t e r adjustment f o r

demographic changes, the f u l l employment rate of unemployment i s now
5.5% t o 6%.

about

The Congressional B u d g e t Office developed a s e t of p r o j e c t i o n s

based o n a less vigorous expansion t h a t reduces i n f l a t i o n .

On the l e s s

vigorous expansion p a t h , unemployment and i n f l a t i o n f a l l to 5.5% and 4.6%
r e s p e c t i v e l y in 1982.

A l l of my e s t i m a t e s s t a r t from t h e s e budget data.

The presumed expansion p r o d u c e s
9.8% i n 1978.

10.4% nominal GNP growth i n 1977 and

Subsequently, n o m i n a l growth i s s t e a d y a t 8.6%, with 4.0%

real g r o w t h and i n f l a t i o n of 4.6%.

No effort i s made to reduce i n f l a t i o n

after 1 9 7 9 , so i n f l a t i o n r a i s e s government revenue by pushing households
into h i g h e r tax b r a c k e t s .

M o r e o v e r , owners of b u s i n e s s firms are taxed

because depreciation of c a p i t a l i s

t i e d to h i s t o r i c c o s t .

The replacement

cost of capital r i s e s with i n f l a t i o n , but d e p r e c i a t i o n does n o t , so
reported profits a r e o v e r s t a t e d b y t h e difference between replacement c o s t
and t h e book value of c a p i t a l .




C o r p o r a t e taxes are i n c r e a s e d i n t h i s way.

7
As one o f

my former students Hai H o n g points out, t h e government continues

to c o l l e c t tax revenues from firms e v e n if i n f l a t i o n ends tomorrow.
course, o w n e r s of c a p i t a l have t a k e n

Of

the loss in t h e s t o c k market, and

new owners of capital i n t e n s i v e f i n n s pay a price t h a t r e f l e c t s

the

estimated a f t e r tax revenues.
The e f f e c t s of i n f l a t i o n on t a x payers remain i n a f u l l y a n t i c i p a t e d
inflation* To these, we must add t h e effects of u n a n t i c i p a t e d
Unanticipated i n f l a t i o n taxes o w n e r s nominal wealth*

inflation.

These e f f e c t s are

more f r e q u e n t l y discussed by e c o n o m i s t s , but they a r e much s m a l l e r than
the e f f e c t s of anticipated i n f l a t i o n on tax payments.
The 4.7% i n f l a t i o n assumed by t h e Congressional
$24 b i l l i o n to Federal tax revenues
1982.

Budget Office adds

in 1978 and t r a n s f e r s $150 b i l l i o n in

F o r the five year period 1 9 7 7 - 8 2 the cumulative i n c r e a s e in tax

payments from i n f l a t i o n i s $408 b i l l i o n .

These sums are obtained using an

average marginal t a x rate of 25% a n d the estimated change i n r e a l income,
obtained from the CBO, to compute t t i e tax revenues t h a t would be c o l l e c t e d
if i n f l a t i o n ended i n 1977.
The $408 b i l l i o n tax revenue f xom inflation i s
c o l l e c t i o n s in the f i v e year p e r i o d

m

16% o f t o t a l tax

The tax revenues from i n f l a t i o n

permit t h e government t o balance t h e budget and t o i n c r e a s e the share of
G P c o l l e c t e d in t a x e s .
N

On the CBO assumptions, F e d e r a l t a x c o l l e c t i c n s

as a percentage of GNP increase b y more than two p e r c e n t a g e points as we
move t o w a r d full employment in 1 9 8 2 .
An estimate o f the c o n t r i b u t i o n of i n f l a t i o n t o r e d u c i n g the budget
deficit




requires an adjustment o f government o u t l a y s .

O u t l a y s increase

8

w i t h i n f l a t i o n by less than t a x e s .

The response of o u t l a y s t o

inflation

computed from CBO p r o j e c t i o n s , i s more variable from y e a r to year than
t h e response o f taxes, s o I used the computed response f o r each year instead
of

the a v e r a g e response for the f i v e y e a r period.
The cumulated d e f i c i t for the f i v e

years 1978 t o 1982 i s $162 b i l l i o n

a t zero r a t e o f i n f l a t i o n and $45 b i l l i o n on the CBO a s s u m p t i o n s .
reduces t h e budget d e f i c i t by more t h a n

$100 b i l l i o n i n f i v e y e a r s .

Inflation
This

i s a crude b u t , I b e l i e v e , u s e f u l measixre of the n e t t r a n s f e r from p r i v a t e
t o public u s e s resulting from the e f f e c t s of i n f l a t i o n on t a x payments.
The c a l c u l a t i o n s l e a v e out many adjustments.

I n t e r e s t on the public

debt would b e changed by the l a r g e r d e f i c i t s and by t h e lower i n t e r e s t
rates r e s u l t i n g from an end t o i n f l a t i o n .

M c a l c u l a t i o n s have used average
y

effects i n s t e a d of the more a c c u r a t e c a l c u l a t i o n s t h a t r e c o g n i z e the d i f f e r e n t
effects on s o c i a l s e c u r i t y t a x e s , e x c i s e s , and p e r s o n a l and corporate t a x e s .
Lower i n f l a t i o n would a l s o change t h e

xreal returns t o c a p i t a l by reducing

t h e tax on e x i s t i n g c a p i t a l , thereby changing the c o m p o s i t i o n of output,
the size o f capital g a i n s and c a p i t a l

gains t a x e s , and the l i k e .

Adjustments

t o steady i n f l a t i o n by i n v e s t o r s and consumers would undo many of the a d j u s t ments t h a t have been made, for e x a m p l e reducing investment i n land or gold
stocks r e l a t i v e to investment in d e p r e c i a b l e c a p i t a l .

A l l of t h e s e , and

many o t h e r , effects on t a x e s , s p e n d i n g and output a r e i g n o r e d .
We c a n n o t hope t o end i n f l a t i o n b y 1978 and remain on a path toward
full employment.

The f i r s t e f f e c t s o f the sharp r e d u c t i o n i n the rate of

monetary expansion w i l l cause r e v i s i o n of plans.
inventories or planned production o r




Those who accumulated

spending on t h e assumption of sustained

9
inflation r o u s t adjust planning to t h e n e w environment.

Unemployment w i l l

increase a n d the growth of output and perhaps output w i l l a t f i r s t

fall.

Gradually, i t w i l l r e t u r n to i t s g r o w t h path at a l o w e r average r a t e of

inflation,

but government payments for welfare a n d unemployment compensation w i l l be larger
and tax c o l l e c t i o n s s m a l l e r .

The actu^al deficit would be much l a r g e r than

the $162 b i l l i o n if t h e r e i s an a t t e m p t to end i n f l a t i o n suddenly.

The

$162 b i l l i o n i s an e s t i m a t e of the e f f e e t of i n f l a t i o n on government revenues
and o u t l a y s , not a p r o j e c t i o n of t h e e f f e c t on the d e f i c i t of an end to
inflation.
In t h e past several y e a r s , we h a v e seen that t h e economy can recover
while i n f l a t i o n is ended gradually.

A. policy of reducing t h e growth r a t e

of money b y stages has brought a r e c o v e r y from r e c e s s i o n , expansion,
reduction i n unemployment and in i n f l a t i o n .
I believe,

Continuation o f gradualism,

can bring i n f l a t i o n to an e n d by the e a r l y

1980 f s.

Despite

growing e v i d e n c e that the p o l i c y o f reducing i n f l a t i o n has ended, I assume
the policy continues, s p e c i f i c a l l y t h a t rates of i n f l a t i o n f a l l by approximately
1 per y e a r to reach zero i n 1982*
%
vigorous expansion p a t h .

R e a l growth i s k e p t a t the CBO's l e s s

The g r a d u a l

reduction of i n f l a t i o n may change t^e

yearly numbers, but any e a r l y r e d u c t i o n s would be o f f s e t b y l a t e r i n c r e a s e s .
The projected budget d e f i c i t f a l l s
in 1982.

Tax c o l l e c t i o n s in 1982 a r e

for $46 b i l l i o n i n 1978 to $5 b i l l i o n

$518 b i l l i o n , about $100 b i l l i o n

lower t h a n under CBO p r o j e c t i o n s , a n d outlays are l o w e r b y $65 b i l l i o n .
budget i s near balance with f u l l employment and no i n f l a t i o n .

The t a b l e

below compares the budget p o s i t i o n a n d GNP r e s u l t i n g from my assumptions
to the CBO estimates.




The

10

I n f l a t i o n , Taxes a n d the Deficit
Year

My A s s u m p t i o n s
Growth
GNP
Taxes
Deficit
o f GNP
( i n current d o l l a r s )
( i n percent)

CBO Assumptions
GNP
Taxes
Deficit
( i n current d o l l a r s )

1977

10.4

1884

362

-50.6

1884

362

-50.6

1978

8.8

2050

400

-46

2075

405

-46

1979

6.6

2186

436

-34

2259

454

-29

1980

5.6

2308

466

-26

2457

505

-14

1981

4.6

2414

494

-14

2673

562

+ 10

1982

4.0

2511

518

- 5

2909

621

+34

My proposed budget has very d i f f e r e n t consequences from the CBO budget,
The s h a r e o f G P taken in taxes by title
N
21.4% t o

Federal government i s reduced from

20.6%. Much of the r e d u c t i o n is the r e s u l t of a small d e f i c i t

instead o f a budget s u r p l u s , but t h i L s is misleading.

1 have made no

provision f o r the reduction in i n t e r e s t payments on t h e Federal debt that
would r e s u l t from t h e removal of i n f l a t i o n premiums i n i n t e r e s t r a t e s .
Average i n t e r e s t r a t e s on the o u t s t a n d i n g debt in 1982 would f a l l from
the 7% p r o j e c t e d by the CBO to 3 o r

3-1/2%, so a f t e r a l l o w i n g for the

larger d e f i c i t s , t h e r e i s a r e d u c t i o n of $15 b i l l i o n or more in o u t l a y s .
I t would be a mistake t o a t t a c l i too much r e l i a n c e t o any of the
estimates o r projections f i v e or s i x years ahead.

The e s t i m a t e s show

that a balanced budget, a smaller s h a r e of G P absorbed by government
N
and an end to i n f l a t i o n are f e a s i b l e and compatible g o a l s .

By 1978,

the p r o j e c t e d budget d e f i c i t s can b e financed with a r a t e o f increase
in the monetary base that i s c o n s i s t e n t with slower i n f l a t i o n and no
further increase in tjie r a t i o of government debt t o b a s e money.




No l a t e r

11

t h a n 1980, t h e

financing o f the d e f i c i t p e r m i t s the Federal Reserve t o

s l o w money g r o w t h and reduce outstanding

public debt t o make room for

additional f i n a n c i n g of housing and p r i v a t e capital f o r m a t i o n .
An A l t e r n a t i v e Pirogram
The d i f f i c u l t i e s I f i n d in the a d m i n i s t r a t i o n ' s program do not l i e as
m u c h with t h e
government.
to

inaccuracies of the p r o j e c t i o n s as in the requirements on
A l l of the p r o j e c t i o n s a s s u m e that Congress h o l d s spending

levels no h i g h e r than t h e p r o j e c t i o n s .

These allow f o r expansion of

e x i s t i n g p r o g r a m s , but permit no a d d i t i o n s .

Every new program must be

matched by a reduction i n an e x i s t i n g program.
Does a n y o n e believe t h a t Congress o r the administration w i l l behave
in

this way?

The $50 b i l l i o n d e f i c i t f o r fiscal 1977 had been increased

to

$70 b i l l i o n by January and w i l l be i n c r e a s e d further.

m o r e than $ 7 5 b i l l i o n f o r f i s c a l
t i o n and t h e

A d e f i c i t of

1977 s e e i n s likely, and the new administra-

new Congress have only begvtn to search out new ways of spending.

T h e increase in fuel c o s t s i s seen as a n opportunity t o grant a d d i t i o n a l
r e l i e f to f a m i l i e s that pay more for h e a t i n g .

At the same t i m e , there are

proposals f o r additional stimulus for t t i e economy on t h e grounds that higher
spending on u t u l i t i e s must be o f f s e t t o
Apparently,

cushion the shock t o employment.

t h o s e who r e c e i v e the a d d i t ± o n a l payment

f o r food or fuel are

expected t o withhold t h e i r r e c e i p t s f r o m the spending s t r e a m , so government
m u s t correct their behavior.
I w i l l n o t dwell on the obvious r e a s o n s why t h i s argument i s wrong. Even
if

i t were c o r r e c t , i t i s f i n e tuning w i t h a vengeance.




Every s h i f t i n spending

12

brings a new program o r an a d d i t i o n t o a n old program.

The government takes

r e s p o n s i b i l i t y for smoothing out t h e r i p p l e s in economic l i f e
t h a t their f o r e c a s t s o f the r i p p l e s a r e

disregarding

subject to l a r g e e r r o r s and that

t h e i r a c t i o n s create u n c e r t a i n t i e s a b o u t the future t h a t are at times as
disturbing a n d unsettling to the economy as the r i p p l e s they attempt to
smooth.
W n e e d n o t continue to r e s t r i c t freedom and reduce e f f i c i e n c y
e
t h e i n t e r e s t s o f full employment.

in

T h e r e i s an a l t e r n a t i v e path to f u l l

employment t h a t uses our r e s o u r c e s , i n c r e a s e s freedom and encourages
efficiency.
I n f l a t i o n , r e s t r i c t i o n s , p r o h i b i t ± o n s and r e g u l a t i o n s not only reduce
the return t o capital and labor and discourage i n v e s t m e n t , but they t r a n s f e r
resources t o l e s s productive u s e s .

If

we reduce the army o f r e g u l a t o r s to

a brigade o r platoon, we r a i s e p r o d u c t i v i t y by t r a n s f e r r i n g resources from
less e f f i c i e n t

to more e f f i c i e n t a c t i v i t i e s .

Those engaged in n e g o t i a t i o n

over the r u l e s and t h e i r a p p l i c a t i o n a r e directed t o more p r o d u c t i v e t a s k s .
Productivity increases and saving i s a t t r a c t e d from t h e many o t h e r places
in the w o r l d where r e s t r i c t i o n s , d i s e n c e n t i v e s , and r e g u l a t i o n s lower the
rate of investment i n new and more p r o d u c t i v e f a c i l i t i e s •
Many countries have followed t h e

path we have f o l l o w e d .

They, t o o ,

restrict freedom and e f f i c i e n c y i n t h e use of r e s o u r c e s , l i m i t returns to
investment, and create uncertainty a b o u t the future.

By i n c r e a s i n g freedom

and encouraging e f f i c i e n c y , we can r a i s e our standard of l i v i n g and develop
opportunities for employment at h i g h e r real earnings and w i t h more freedom
to decide how we spend our incomes.




13

This

i s a long-term program, fox: improving the e f f i c i e n c y with which

we use resources and improving the performance of the economy.

Unemployment

is generally regarded as a current problem that we must solve sooner than
m proposals permit.
y

If this i s corxrect, we must recognize that much of our

long-term unemployment i s the r e s u l t

of past policies particularly the

minimum w a g e law and r e s t r i c t i o n s on entry into professions and occupations
written i n t o local and national laws •

Few actions would have more effect on

long-term unemployment of teenagers than the removal of minimum wage laws
and other barriers to entering the l a b o r market.
Ending inflation, increasing employment, reducing the burden of a
large government, increasing e f f i c i e n c y and encouraging freedom are compatible
goals t h a t can be achieved by t h i s administration, i f they avoid three
temptations: to fine tune the economy, to preserve and nurture the growth
of bureaucracy, and to believe that they can choose t o increase employment
now and reduce inflation later.




INTERNATIONAL ECONOMIC POLICY
A B r i e f i n g of t h e Shadow O p e n Market C o m m i t t e e
March 7, 19 7 7
By W i l s o n

I.
President
from

What's

cut o u t t h e i r

away

inter-

trav-el.

President's

Appropriations
(February 1,

Committee h i g h l i g h t e d

a s p e c t of t h e

I n addition,

a b i l i t y of a

economy

Slow-downs
there is

number o f c o u n t r i e s ,

their

domestic p r o g r a m was two

continued c u r r e n t

a r e foreseen i n

receipts from

t h e same s o u r c e s ;

in

industrial

b o t h i n d u s t r i a l and
account d e f i c i t s ,

growth, r e d u c e

the

developing,
that

s e r v i c e s , and g i f t s

turn, this r a i s e s

capacity to sustain t h e i r

m e n t , and c o n t r o l

importantly

gx*owing c o n c e r n a b o u t

e x c e s s p a y m e n t s for i m p o r t s of g o o d s ,

a b o u t their

presenting

the i n t e r n a t i o n a l

American e c o n o m i c health depends

on o u r e x p o r t m a r k e t s .

finance

in

19 7 7 ) .

p r o n g e d and s i m p l e .

countries.

M r . Blumenthal,

domestic e c o n o m i c r e c o v e r y p r o g r a m t o t h e House

The i n t e r n a t i o n a l

to

t o take t h e l i m o u s i n e s

but he c e r t a i n l y h a s n ' t

The S e c r e t a r y of t h e T r e a s u r y ,
the

Hew?

C a r t e r may h a v e t r i e d

the s t a f f ,

national

Schmidt"*

is,
over

doubts
unemploy-

inflation.

^ P r o f e s s o r a n d Head, D e p a r t m e n t o f Economics, V i r g i n i a P o l y t e c h n i c
I n s t i t u t e a n d S t a t e U n i v e r s i t y ; D e p u t y A s s i s t a n t S e c r e t a r y , U. S.
T r e a s u r y , 19 7 0 - 7 2 .




2

T h e solution, to both problems accorrding to the S e c r e t a r y
lies i n

the expansion of t h e f i n a n c i a l l y and economically strong

c o u n t r i e s w o m u s t run current account
h

deficits.

Underlying b o t h problems, a c c o r d i n g to Secretary B lumen t h a i ,
is the persistent: external surplus of t t i e oil-producing c o u n t r i e s .
(The Organization for Economic C o o p e r a t i o n and Development, the
OECD, w h i c h is t h e rich c o u n t r i e s ' c l u b ,

projects t h e s e t o continue

in 1977 at about $37 b i l l i o n compared w i t h $42 b i l l i o n i n 1976;
see i t s

Economic Outlook, December, 19 7 6 , page 10.)

The weak

c o u n t r i e s must r e d u c e t h e i r d e f i c i t s t o preserve t h e i r crectit
w o r t h i n e s s and m u s t "depend on us f o r export-led growth," according
to Secretary Blurnenthal.
reduce

The strong c o u n t r i e s must t h e r e f o r e

their c u r r e n t account s u r p l u s e s .

T h e arguments were sharpened t h r e e days l a t e r , upon t h e r e t u r n
of t h e Vice P r e s i d e n t , Mr. Mondale, from ten days abroad.
Undersecretary o f State for Economic

The

Affairs-Designate,

Mr. Richard Cooper, was reported to h a v e estimated t h a t t h e world
was l o s i n g $300 b i l l i o n i n unused r e s o u r c e s because of s l u g g i s h
economic growth.

The Assistant S e c r e t a r y of the T r e a s u r y - D e s i g n a t e ,

Mr. F r e d Bergsten, was c i t e d , saying t h a t the United S t a t e s was
s e e k i n g to induce Japan and Germany t o move from a " s m a l l to big
c o u n t r y psychology." They should t h i n k of themselves a s
of t h e world economy."




M

engines

(Journal of Commerce, February 3, 1977) •

3

As Mr. Blumenthal put i t ,

!l

.

. .

the United S t a t e s i s a s s e r t -

ing leadership and encouraging the stxronger countries abroad to
f o l l o w suit.

We are i m p l i c i t l y and e x p l i c i t l y asking them to

f o l l o w a course of stimulating t h e i r economies much as we are
proposing for t h e United States

. . . "

Though t h e Administration did not: specify i t s c r i t e r i a , i t i s
easy t o see why t h e Federal Republic o f Germany (FRG) and Japan
were singled o u t .

Of the seven l a r g e s t countries, a l l ran current

a c c o u n t d e f i c i t s i n 19 76 except Japan

and the FRG.

And they also

enjoyed the l a r g e s t holdings of o f f i c i a l international r e s e r v e s ,
after

the United S t a t e s .
And one w o u l d not expect the Administration to name the

p a r t i c u l a r c o u n t r i e s where current account d e f i c i t s might be hard
to finance.

B u t the numbers do not d e n y the p o s s i b i l i t y of the

problem. For example, between 19 73 a n d 1975, the e x t e r n a l debt of the
LDCs almost d o u b l e d and the r a t i o of d e b t service payments to
merchandise e x p o r t s rose from 157o to 207 0 .
Report of the P r e s i d e n t , January 1977,

( I n t e r n a t i o n a l Economic

p. 30f.).

The members of

OECD accumulated n e t current account d e f i c i t s of $60 b i l l i o n since
1974, but $70 b i l l i o n was accounted f o r by countries having only
30% o f the combined gross product of t h e O C n a t i o n s .
ED
Economic Outlook, December 19 76, p.

(OECD,

10.)

Mixed i n w i t h t h i s picture are e s t i m a t e s t h a t commercial banks
r a i s e d their s h a r e of the new e x t e r n a l




financing of the LDCs from

4

20% in 1971-73 t o over 40% in 1974-76.
sources

The official

multilateral

seem to b e running out of r e s o u r c e s to lend, f o r example

the I n t e r n a t i o n a l Monetary Fund had t o t u r n to the General
Arrangements to Borrow to finance t h e B r i t i s h loan and the IMF's
Oil F a c i l i t y ended in March 19 76. (Morgan Guaranty T r u s t , World
F i n a n c i a l Markets , January, 1977).

W i t t i commercial banks holding

$75 b i l l i o n of t h e estimated e x t e r n a l d e b t of $180 b i l l i o n of the
LDCs, concern o v e r the willingness of tine private sources to
c o n t i n u e their support of current a c c o u n t deficits a r i s e s .




II.

A Lone Ranger?

T h e Administration's diagnosis a n d proposed s o l u t i o n had
s u p p o r t on the H i l l .

Worried about l a i r g e U. S. budget

deficits

being " p o l i t i c a l l y unattractive, 1 1 the Senate Budget Committee
"There i s no reason why,11 the U.

wrote

S. alone must b e a r the

r e s p o n s i b i l i t y f o r stimulating the w o r l d economy . . . "Other
s t r o n g industrial economies - notably Germany and Japan - must
share

the r e s p o n s i b i l i t y to provide t h e fiscal and monetary

s t i m u l u s that w o r l d economic recovery r e q u i r e s . "

(Wall S t r e e t

Journa.1, December 17, 19 76.)
T h e O C i n i t s December r e p o r t o n the economic outlook pressed
ED
Japan,

the FRG, and the United S t a t e s f o r expansion.

It

forecast

a s l o w e r rise i n t h e real gross product: of the OECD c o u n t r i e s
from 57o in 1976 t o 3.75% in 1977.

Compared with i t s r e p o r t s i x

months earlier, t h e l a t e s t was n o t a b l y

more p e s s i m i s t i c .

I t also

e x p r e s s e d concern about the a b i l i t y of

some of i t s member nations

to f i n a n c e t h e i r expected current a c c o u n t deficits and added t h a t
some o f the n o n - o i l developing c o u n t r i e s might be in t r o u b l e as
well.
T h e Ford Administration r a i s e d t h e same problems t h a t could
have Led to the same diagnoses as t h o s e of the S e c r e t a r y but
w i t h o u t coming down on policy p r e s c r i p t i o n s .

(Economic Report

of t h e President, January, 1977, C h a p t e r 3.)

Perhaps t h e major

d i s c e r n i b l e difference between the p r e s e n t and previous




Administrations

6

is t h a t

the shoe i s on the o t h e r f o o t .

r e s i s t e d entreaties from other n a t i o n s

The Ford Administration
xncluding Japan and

Germany to expand i n 1975 and e a r l y 197 6 ; this Administration
i s inv±ting s e l e c t e d , cooperative e x p a n s i o n .




7

III.
Is

Some Questions (and Answers?)

the world headed for a slow-down?

Is the financing for

e x p e c t e d current account d e f i c i t s inadequate?

If so, w i l l the

FederaX Republic a n d Japan comply with t h e Administration's
request?

And i f

t h e y do w i l l i t turn tine

trick?

Obviously, t h e s e are not easy q u e s t i o n s to answer.
A.

Prospects f o r a Slow-Down
As for the OEGD area, leaving a s i d e the United S t a t e s , there

was an unmistakable decline i n the r a t e

of growth of the combined

i n d u s t r i a l production of the s i x o t h e r xnajor members (Canada,
France,

Germany, I t a l y , Japan, and the United Kingdom) in the

l a s t q u a r t e r of 19 76 over the year as a whole, supporting the
n o t i o n of a slow-down in 1977.

(CIA, E conomic I n d i c a t o r s ,

F e b r u a r y 16, 1977; I used 1974-75 s h a r e s of their combined gross
p r o d u c t as weights . )
Furthermore, there was a l s o a s h a r p decline in the r a t e of
growth ( i t a c t u a l l y became negative) i n

the real money balances

of t h o s e same members in the l a s t q u a r t e r of 1976 over 19 76 as a
whole,

further supporting the notion o f a decline in economic

a c t i v i t y in 1977.

(Ibid.)

B u t this evidence i s not d e c i s i v e .
t h e U. S., the OECD projects a decline

For example, excluding
in the r a t e of i n c r e a s e

of t h e gross p r o d u c t from 3.8% to 3.37o between 1976 and 19 77, well




8

within

the p o s s i b l e range of f o r e c a s t i n g error.

More importantly,

p e r h a p s , the s h a r p decline in r e a l money balances noted above i s
almost: entirely a t t r i b u t a b l e to developments in I t a l y and the
United Kingdom.

These are the only two of the seven t o show

an i n c r e a s e in t h e i r rates of p r i c e i n f l a t i o n in the l a s t three
months of 1976 o v e r the year as a whole .
t h e i r average r a t e s of i n f l a t i o n s i n c e
only t w o to d i s p l a y faster i n f l a t i o n i n
except

And, in comparison with

19 70, they are a l s o the
the last t h r e e months or,

for France by a small margin, o v e r the year as a whole.

By

c r e a t i n g uncertainty, i n f l a t i o n in I t a X y and the United Kingdom
may h a v e been t h e chief cause of t h e i r

unemployment and r e c e s s i o n s .

D e c l i n i n g real balances may slow p r i c e

inflation, c r e a t e more

c e r t a i n t y , and thereby stimulate t h e i r

growth and employment.

And for t h o s e who l i k e l a r g e - s c a l e econometric models,
P r o f e s s o r Lawrence Klein p r o j e c t s a r i s e in the OECD r e a l output
from 3.15% to 5.5% between 1976 and 19 7 7.

( I n t e r n a t i o n a l Financial

News Survey, January 10, 1977)
I t is hard t o know t h a t the A d m i n i s t r a t i o n i s wrong, but i t
i s a l s o difficult
B.

to be confident t h a t

i t is r i g h t .

C u r r e n t Account Financing
T h e Administration's concern a b o u t the a b i l i t y of

countries

to f i n a n c e t h e i r current account d e f i c i t s i s extremely

difficult

to a s s e s s .




9

The reasons are obvious.
The assessment of a c o u n t r y ' s a b i l i t y to carry p r e s e n t or
added debt is a judgement c a l l , where

the answer depends upon a

wide range of p o l i t i c a l and economic v a r i a b l e s , including whether
or n o t those v a r i a b l e s would permit a policy-directed r e d u c t i o n
in t h e deficit t o be financed.
The e a s i e s t argument in support o f the Administration i s
that i f its p r o p o s a l s and pressures w o u l d induce i n f l a t i o n in
the creditor c o u n t r i e s (which i t e x p l i c i t l y does not d e s i r e ) , the
r e a l burden on foreign debtors would f a l l .

But in a world where

n o m i n a l rates o f i n t e r e s t seem to a d j u s t quickly to expected r a t e s
of i n f l a t i o n , s o that i n f l a t i o n would -raise debt s e r v i c e payments,
t h i s l i n e of r e a s o n i n g i s far from p e r s u a s i v e .
Another argument which would s u p p o r t the Administration would
be t h a t the problem of current account
f i n a n c i n g is so general that a s e r i e s

deficits and t h e i r
o f defaults, world-wide,

would ensue t h a t might break the f a b r i c of the f i n a n c i a l system.
B u t the problem seems to be more localized than g e n e r a l .
W i t h o u t mentioning t h e i r names, the OECD seems to be w o r r i e d about
the U . K . , France, and I t a l y .

(See t h e

the OECD, Economic Outlook, December,

countries not mentioned by
1976, p. 10.)

But since these

c o u n t r i e s have f l o a t i n g exchange r a t e s , there i s no reason to assume
t h a t t h e current account d e f i c i t s are ± n t r a c t a b l e ; a f t e r a l l ,
and c u r r e n t t r a n s a c t i o n s adjust to one




another to equate t o t a l

capital

10

i n f l o w s and o u t f l o w s of foreign e x c h a n g e .

(The OECD forecasts

assume no change in exchange r a t e s . )
As for t h e LDCs, in the eye of o n e keen observer, "The
judgement of t h e United S t a t e s Government, the World Bank, and
most private b a n k e r s is t h a t t h e r e i s

no global problem, no serious

t h r e a t of massive defaults or debt r e p u d i a t i o n .

(Edwin L. Dale, J r . ,

The Nev York T i m e s , January 30, 1 9 7 7 . )
Again, i t

i s difficult to show t t t a t the Administration i s wrong,

but i t is hard t o be confident t h a t i t
C.

is right.

W i l l Japan and the FRG Respond?
Who knows ?
The Vice P r e s i d e n t , upon h i s r e t m m , stated that the three

c o u n t r i e s are i n "substantial a g r e e m e n t " on the need to help
"stimulate 1 1 w o r l d recovery.

But he acknowledged t h a t the three

governments may differ on the " s i z e " o f the necessary s t i m u l u s .
( J o u r n a l of Commerce, February 3, 1977".)

While r e p o r t s emanating

from abroad suggested t h a t Japan and Germany reacted t o t h e
A d m i n i s t r a t i o n ' s recommendations l e s s

favorably than t h a t , i t i s

d i f f i c u l t to t e l l how much of t h i s w a s for domestic consumption
and how much was for r e a l .
D.

W i l l It Turn the Trick?
Obviously t h e Administration, by

i t s own words, i s not s u r e .

S e c r e t a r y Blumenthal t e s t i f i e d on J a n u a r y 27 t h a t " . . . i t i s easy




to overestimate

t h e magnitude of the contribution t h a t

faster

growth in Japan, Germany, and the U n i t e d States can make in
f o s t e r i n g the needed adjustments i n t h e weaker c o u n t r i e s .
one p e r c e n t r i s e i n the r e a l GNP of t h e

n

A

big three" would r e s u l t

in an increase i n their combined impoirt: demand on the order of
$4 b i l l i o n in 1 9 7 7 , of which only 60% o r about $2.4 b i l l i o n , could
d i r e c t l y benefit the f i n a n c i a l l y w e a k e x countries. 11
Budget Committee, p. 6)

(House

For b a l l - p a r k : comparison, t h e world GNP

excluding those three countries and t h e Soviet .Union and China
i s probably around $5,000 b i l l i o n .

(Xnternational Economic Report

of t h e President, o p . c i t . Table 2.)
The S e c r e t a r y ' s scenario depends
deny him his o b j e c t i v e s .

upon some

i f s " which could

More fundamentally, can p r o s p e r i t y be

t r a n s m i t t e d from one country to a n o t h e r or is p r o s p e r i t y chiefly
made a t home?
First, look .at the issue from t h e Keynesian p o i n t of view, a
view which focuses on the effects of

changes in the c u r r e n t account

on aggregate demand.
Suppose t h a t the FRG expands i t s
i m p o r t s increase.

internal demand.

Germany's

And, by d e f i n i t i o n , exports to Germany also r i s e ,

a d d i n g , at l e a s t p o t e n t i a l l y , to a g g r e g a t e demand i n t h e r e s t of
the world.
When Germany's imports r i s e , t h i s increases t h e supply of
marks on the foreign exchange market .

Ij? the German c e n t r a l bank

does not buy up those marks, the v a l u e of the German mark on the
f o r e i g n exchange market must f a l l .




This makes German goods more

12

competitive.

O t h e r countries w i l l d i v e r t their purchases toward

German products a n d avay from t h e i r own goods.
aggregate demand i n the r e s t of t h e w o r l d .
happens , German exports must r i s e by an

This reduces

If! nothing e l s e

amount equal to the

i n c r e a s e in i t s imports, causing no net: decrease in Germany's
current account surplus and thus no d e c l i n e in the c u r r e n t account
d e f i c i t s of o t h e r countries.

In s h o r t ,

there is no net t r a n s -

mission of demand from Germany to the o u t s i d e world.
the transmission might work p e r v e r s e l y .

In f a c t ,

!£ the expansion of

demand in Germany i s achieved through l o w e r i n t e r e s t rates-,

capital

will f l o w out of t h e FRG, further i n c r e a s i n g the supply of marks on
the foireign exchange market.
a g a i n s t foreign c u r r e n c i e s .

This d e p r e s s e s the mark even more
In the e n d , the mark w i l l f a l l in value

u n t i l t h e extra imports by the FRG p l u s the flow of c a p i t a l from
the FRG just matches the increase i n German exports.

The German

c u r r e n t account surplus r i s e s to f i n a n c e the extra c a p i t a l e x p o r t s ,
e x a c t l y the o p p o s i t e of the desired r e s u l t .
From the m o n e t a r i s t point of v i e w ,

the exercise a l s o f a i l s .

As German imports r i s e , foreign e x p o r t e r s receive a d d i t i o n a l marks
which they s e l l on the foreign exchange market for t h e i r own
currency.

If t h e foreign c e n t r a l bank

does not buy and hold those

e x t r a marks, i t does not issue newly-cheated money to buy those
marks; the stock of money outside of Germany does not r i s e , and
a g g r e g a t e demand abroad therefore c a n n o t increase d e s p i t e the r i s e




13

in exports.

The currency simply a p p r e c i a t e s until the inflow of

marks a n d the outflow of marks are e q u a l .
F o r the scheme to work, on the Keynesian analysis, the German
central bank must buy up the e x t r a m a r k s when Germany's imports and
c a p i t a l exports increase.

This p r e v e n t s the decline i n the value

of the mark on t h e foreign exchange marlcet.

As a consequence,

German exports w o n ' t rise, and the German current account surplus
must diminish.

I f the German expansion

brings i n t e r n a l

inflation,

t h i s r e s u l t i s strengthened as German g o o d s become l e s s competitive
while t h e exchange rate stays c o n s t a n t .
A l t e r n a t i v e l y , in the monetarist framework, i f the foreign
c e n t r a l banks buy the marks to hold, t h e y will issue t h e i r own
new l o c a l money t o buy those marks from

those who export to

Germany ; this expands the stock of money at home and s t i m u l a t e s
i n t e r n a l demand a s exports r i s e .
The central problem i s now apparent!. Fine tuning with an
i n t e r n a t i o n a l o r c h e s t r a r e q u i r e s a s t r o n g conductor--fixed exchange
rates.

But Germany, Japan, and the U n i t e d States do not automatically

f i x t h e i r rates of exchange or, in our example, buy up t h e i r
c u r r e n c i e s as t h e i r imports of goods o r
of the r e s t of t h e i n d u s t r i a l world i s
receive the German transmission.

capital exports r i s e .

Much

f l o a t i n g so t h a t i t cannot

Some o f the developing countries

t i e t h e i r c u r r e n c i e s to one of the majox- currencies, c h i e f l y the
d o l l a r , but then t h e i r currencies f l o a t
non-dollar currencies.




automatically a g a i n s t

14

This i s n o t to say t h a t the S e c r e t a r y i s wrong.

I t is j u s t

to say that t h e process i s c o m p l i c a t e d and the r e s u l t s are
there fore prob 1 ematical,





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