Full text of Policy Statement and Position Papers : March 8, 1976

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SHADOW OPEN MARKET COMMITTEE
Policy Statement and Position Papers

March 8, 1976

1. Shadow Open Market Committee Policy Statement, March 8, 1976
2. SOMC Members – March 8, 1976
3. Position Papers




Monetary Policy, Economic Expansion and Inflation – Karl Brunner, University of Rochester
Implications of Possible Monetary Growth Targets – A. James Meigs, Claremont Men’s
College
Briefing for the Shadow Open Market Committee Meeting – Wilson E. Schmidt, Virginia
Polytechnic Institute and State University
Comments on Past, Current, and Future Fiscal Policy Developments – Robert H. Rasche,
Michigan State University

Directive
Shadow Open Market Committee
March 8, 1976
Economic activity continues to expand at a moderate rate, and the rate of
inflation continues to fall. Continued moderate growth and further gradual
reduction in the rate of inflation are likely prospects for the near-term if
an appropriate monetary policy is adopted and remains in effect.
Recent Monetary Policy
At its meeting today, the Shadow Open Market Committee reviewed recent developments in the economy and in economic policy and their effects on recovery and
future inflation. The Committee noted that fiscal stimulus stayed within the
range projected. The growth of the money stock -- currency and demand deposits -has remained below the 5,5% rate of growth that the Committee recommended at its
previous meetings as an appropriate course during the recession and the early
stages of expansion.
During 1975, the annual average growth of money on a quarterly basis was 4.4%.
Much of this growth was the result of a very high rate of monetary expansion
in the second quarter. During the last quarter of 1975 and in early 1976, the
growth rate of money was below, often far below, the growth rate we recommended
and the minimum growth rate chosen by the Federal Reserve as a target.
Continuation of sluggish monetary growth would reduce the growth rate of output,
slow the recovery and increase the costs of slowing inflation. A slower than
expected recovery would increase the pressure for greater fiscal and monetary
expansion and a return to the policies that brought high inflation.
Recent monetary growth has been defended on the ground that there has been a
change in established relations between money and economic activity and inflation.




Directive - SOMC/2

This is not the first time that policy makers have justified inappropriate
actions by arguing that established relations are no longer valid. Generally,
conjectures of this kind about a new and different era have proved to be
vacuous ~ empty justifications of past developments.
The risk of error is much too great to justify recent retardation in monetary
growth. The growth of money should be brought close to the range that would
have been achieved if our recommendation in September 1975 had been followed.
Reducing Long-Term Inflation
The long-term problem of inflation remains. Even if a rate of inflation of
5% is attained on the average for this year, we will enter 1977 with inflation that is high by historical standards. The rate of inflation must be
reduced further in 1977 and beyond.
Inflation in 1977 depends on the policies of 1976 and earlier years. Although
the rate of monetary expansion during the second half of 1975 makes the recovery slower than it would otherwise have been and raises the costs of reducing inflation, slow monetary growth also lowers inflation. It would be a
mistake, we believe, to dissipate the benefit -- lower inflation — by shifting
to a highly expansive policy. That would be a return to "stop and go.11
The Committee recommends that the Federal Reserve maintain a 4.5% growth rate
of money from March 1976 onward. This growth rate should start from a base
of $300-billion in March 1976 or a first-quarter average of $297.5-billion.
Such a rate would mean the money stock would rise to $304-billion by the third
quarter of 1976 and $311-bi11ion by the first quarter of 1977. A 4.5% rate is
below the rate we recommended in March and September 1975 but above the recent
rate of monetary expansion. It essentially extends the annual average rate
the Federal Reserve produced for 1975.




Directive - SOMC/3
The rate of monetary expansion

for the near future that we recommend is

above the long-term rate consistent with zero inflation. Further reductions will
be required as the economy recovers and uses resources more fully.
Instability and Control
The Federal Reserve, the Deutsche Bundesbank, and the Swiss National Bank announced
target rates of expansion for monetary aggregates in 1975. The Swiss and Germans
achieved their targets. For 1976 they have announced new single targets, not
shifting bands.

The Federal Reserve, on the other hand, has not achieved its announced target.
Federal Reserve implementation is so erratic that monetary growth strays far from
the announced target. The target, furthermore, shifts. Although the Federal Reserve
announces a planned range of monetary growth rates over the coming year, each quarter it proposes to follow the growth path starting from the existing level of the
monetary aggregates. The base values from which the growth path is calculated thus
shift each quarter.

In effect, the Federal Reserve confines its operations to a

quarterly target, contrary to the intent of House Concurrent Resolution 133.
High variability of monetary growth increases instability and uncertainty about
the economy. We find no justification for erratic actions.
The Federal Reserve should be able to achieve what other central banks achieve —
a growth rate of money consistent with the announced target.
The Bundesbank and the Swiss National Bank achieved their targets because their
operating procedures are appropriate for controlling monetary aggregates. The
Federal Reserve fails to achieve its announced target because its operating procedures
are inappropriate. These procedures must be changed so that monetary policy can
contribute more to stability than to instability in the future.




Policy Directive - SOMC/4

We propose two changes in present procedures:

(1) The Federal Reserve should seek

to establish a direct link between monetary aggregates and the required size of
open market operations, and eliminate reliance on the Federal Funds rate as a guide.
(2) The Federal Reserve should reform institutional arrangements of its own devising that hamper its control of the aggregates. Examples of such arrangements are
the proliferation of deposit categories subject to different interest rate ceilings,
and the system of lagged reserve requirements.




Karl Brunner
H, Eric Heineman
Homer Jones
Jerry L, Jordan
Thomas Mayer
A* James Meigs
Allan Meltzer
Robert Rasche
Wilson Schmidt
Anna Schwartz
William Wolman

University of Rochester
Morgan, Stanley & Company
St. Louis, Missouri
Pittsburgh National Bank
University of California
Claremont College
Carnegie-Mellon University
Michigan State University
Virginia Polytechnic Institute
National Bureau
Business Week

ECONOMIC OUTLOOK
(BILLIONS OP DOLLARS—SEASONALLY ADJUSTED ANNUAL RATES)
ACTUAL
75:1

JANUARY 28, 1976

FORECAST
75:2

75:3

75:4

76:1

76:2

8 61641.0
9.0

76:3

76:4

ANNUAL
1972

ANNUAL
1973

ANNUAL
1974

ArtNUAL
1975

ANNUAL
1976

GROSS NATL PRODUCT
%CH

1433.6 1460.6 1523.5 1573.2 1606.0
12.2
7.7
19.9
-2.1

1681.0 1721.0
9.9
10.1

1171.1
10.1

1306.3
11.5

1406.9
7.7

1499.0
6.5

1662.2
10.9

f^LCONSTANT DOLLAR GNP
%CH

1158.6 1168.1 1201.5 1217.4
|1226.9
5.4
11.9
-9.2
3.3
\
3.2

1238.5 1253.5 1268.2
4.8
5.0
3.8

1171.1
5.7

1233.4
5.3

1210.7
-1.8

1186.4
-2.0

1246.8
5.1

1.2374 1.2504 1.2721 1.2922 1.3090
7.8
7.1
4.3
6.5
5.3

1.3250 1.3410 1.3570
4.9
4.9

0.9999
4.1

1.0590
5.9

1.1625
9.8

1.2630
8.6

1.3330
5.5

1037.5 1062.5 1087.5
9.7
10.0
7.7

733.0
9.7

808.6
10.3

885.8
9.6

963.1
8.7

1051.5
9.2

PRICE DEFLATOR
%CH
CONSUMPTION EXPENDITURES
%CH

1 -

926.4
8.2

950.2
10.7

977.4
12.0

998.6 1018.5
8.2
9.0

DURABLES
%CK

118.9
5.6

123.8
17.5

131.8
28.5

136.1
13.7

138.0
5.7

140.0
5.9

147.0
21.6

152.0
14.3

113.2
14.6

123.0
10.5

121.9
-0.8

127.7
4.7

144.2
13.0

NOMHURABLES
%CH

394.1
7.4

404.8
11.3

416.4
12.0

424.8
8.3

434.0
3.9

442.0
7.6

451.0
8.4

462.0
10.1

299.4
7.8

334.4
11.7

375.7
12.4

410.0
9.1

447.2
9.1

SERVICES
%CH

413.4
9.6

421.6
8.2

429.2
7.4

437.7
8.2

446.5
8.3

455.5
8.3

464.5
8.1

473.5
3.0

322.4
9.9

351.3
8.9

388.2
10.5

425.5
9.6

460.0
8.1

168.7
-58.5

161.5
-16.0

195.1
113.0

203.2
29.7

219.0
22.4

230.5

239.0
15.6

248.5
16.9

188.2
17.7

220.4
17.1

212.2
-3.7

183.4
-13.6

23*.2
27.7

149.3
-4.7

146.1
-8.3

146.8
1.9

152.7
17.1

155.5
7.5

1GJ.0
12.1

165.0
13.1

169.0
10.1

11G.8
12.3

13G.5
16.8

147.9
8.4

148.7
0.6

1G2.4
9.2

PRODUCERS DUR EQUIP
%CH

94.4
-2.5

95.0
2.6

95.6
2.6

99.3
16.4

101.0
7.0

104.0
12.4

107.5
14.2

111.0
13.7

74.3
14.7

87.5
17.8

93.5
6.8

96.1
2.8

105.9
10.2

BUSINESS STRUCTURES
%CH

54.9
-3.3

51.1
-24.9

51.2
0.3

53.4
18.3

54.5
8.5

56.0
11.5

57.5
11.2

58.C
3.5

42.5
8.1

49.0
15.1

54.4
11.1

52.7
-3.2

56.5
7.3

RESIDENTIAL STRUCTURES
%CH

44.2
-32.1

45.C
7.4

50.4
57.4

55.7
49.2

62.0
53.5

65.5
24.6

70.0
30.4

71.5
8.9

62.0
25.1

66.5
7.2

54.6
-17.9

48.8
-10.5

67.2
37.7

INVENTORY CHANGE

-24.8

-29.6

-2.1

-0.2

1.5

5.0

4.0

8.0

9.4

17.5

9.3

-14.2

4.6

17.3

24.2

22.1

22.4

16.0

14.0

14.0

13.0

-3.3

7.4

7.7

21.5

14.3

321.3
8.9

324.7
4.3

3*34.1
12.1

343.8
12.1

352.5
10.5

359.0
7.6

365.5
7.4

372.0
7.3

253.2
8.3

'270.0
6.6

301.1
11.5

331.0
9.9

362.2
9.4

119.4
4.1

119.2
-0.7

124.2
17.9

129.7
18.9

134.0
13.9

136.0
6.1

138.0
6.0

140.0
5.9

102.2
6.1

102.0
-0.1

111.7
9.5

123.1
10.3

137.0
11.3

81.4

82.1

84.0

37.4

90.0

91.0

92.0

93.0

73.5

73.4

77.4

84.0

91.5

33.0

37.1

39.3

42.3

44.0

45.0

46.0

47.0

28.6

28.6

34.3

39.2

45.5

201.9
11.9

205.5
7.3

209.9
8.8

214.1
8.2

218^5
8.5

223.0
3.5

227.5
8.3

232.0
8.1

151.0
9.8

168.0
11.2

189.4
12.8

207.9
9.7

225.2
8.4

INVESTMENT EXPENDITURES
%CM
NONRES FIXED EXPEND
%CH

NET EXPORTS
GOVT PURCHASES
%CH
FEDERAL
%CH
MILITARY
OTHER
STATE & LOCAL
%CH

NOTE:
PERCENTAGE CHANGES AT ANNUAL RATES; PRELIMINARY" DATA FOR



75.4

(BILLIONS OF D O L L A R I ~ S E A I S N A H Z Y ° A D J U S T E D ANNUAL RATES)
ACTUAL

FORECAST
ANNUAL
1972

ANNUAL
1973

ANNUAL
1974

ANNUAL
1975

ANNUAL
1976

144.0
15.2

89.6
16.3

98.6
10.1

93.6
-5.0

107.9
15.3

136.2
26.3

-11.0

-12.0

-6.6

-18.5

-38.5

-11.5

-11.8

144.0
5.8

150.0
17.7

156.0
17.0

96.2
17.3

117.0
21.7

132.1
12.9

119.4
-9.6

148.0
24.0

55.4
-2.2

56.2
5.8

58.5
17.7

60.8
17.0

41.5
10.2

48.3
16.2

52.6
9.1

46.4
-11.9

57.7
24.5

86.6
-2.2

87.8
5.8

91.5
17.7

95.2
17.0

54.6
23.3

68.8
26.0

79.5
15.6

73.0
-8.2

90.3
23.6

1203.6 1223.8 1261.7 1294.8 1320.0 1345.0 1379.0 1409.0
3.0
6.9
9.0
13.0
10.9
8.0
7.8
10.5

942.6
9.7

1054.3
11.9

1154.7
9.5

1246.0
7.9

1363.2
9.4

198.1
11.3

141.2
21.5

151.2
7.1

171.2
13.2

169.2
-1.2

190.1
12.4

1024.0 1081.7 1087.1 1114.4 1137.5 1158.1 1186.2 1210.9
3.2
24.5
2.0
10.4
8.6
8.5
7.5
10.0

801.3
7.9

903.1
12.7

983.5
8.9

1076.8
9.5

1173.2
8.9

751.9
9.7

830.5
10.4

909.5
9.5

987.2
8.5

1079.0
9.3

75:1

75:2

75:3

75:4

76:1

76:2

7(5:3

76:4

83.4
-12.0

101.6
120.2

119.6
92.0

127.0
27.1

129.0
6.4

133.0
13.0

139.0
19.3

-13.7

-6.6

-9.9

-15.8

-13.0

-11.0

PRETAX PROFITS 21
%CH

97.1
-62.3

108.2
54.2

129.5
105.2

142.8
47.9

142.0
-2.2

TAX LIABILITY
%CH

37.5
-66.3

41.6
51.4

50.7
120.6

55.7
45.6

AFTER TAX PROFITS*
%CH

59.6
-59.5

66.6
55.9

78.8
96.0

87.1
49.3

PRETAX PROFITS* & IVA ll
%CH
INV VAL ADJ

(IVA)

PERSONAL INCOME
%CH
TAX & NONTAX PAYMENT
%CH

179.6
1.6

DISPOSABLE INCOME
%CH

PAGE 2

142.1
-60.8

174.6
127.9

180.4
14.0

182.5
4.8

186.9
9.9

192.8
13.4

PERSONAL OUTLAYS
%CH

950.4
7.9

974.1 1001.3 1023.1 1045.4 1064.8 1090.2 1115.6
10.4
9.7
7.6
11.6
9.0
9.0
9.9

PERSONAL SAVINGS
%CH

73.6
-39.6

107.6
356.8

85.8
-59.6

91.3
28.2

92.1
3.5

93.3
5.4

96.0
11.9

95.3
-2.7

49.4
-13.9

72.6
47.1

74.0
2.0

89.6
21.0

94.2
5.1

7.2

9.9

7.9

8.2

8.1

8.1

8.1

7.9

6.2

8.0

7.5

8.3

8.0

EMPLOYMENT
%CH

84.146 84.311 85.283 85.410 86.000 86.500 87.200 88.000
-7.2
0.8
4.7
0.6
3.7
2.8
2.3
3.3

81.671
3.2

84.408
3.4

85.971
1.9

84.787
-1.4

86.925
2.5

LABOR FORCE
%CH

91.810 92.514 93.084 93.234 93.700 94.200 94.700 95.200
0.1
3.1
0.6
2.0
2.2
2.1
2.5
2.1

86.508
2.8

88.711
2.5

91.073
2.7

92.661

1.7

94.450
1.9

7.6

5.6

4.9

5.6

8.5

8.0

13.769 13.855 14.088 14.254 14.26cfTtf.318 14.375 14.412
-2.1
4.8
6.9
0.4
1.6
1.0
2.5
1.5

14.338
2.4

14.613
1.9

14.083
-3.6

13.991
-0.7

14.343
2.5

SAVING RATE(%)

8.3

UNEMPLOYMENT RATE(%)
PRODUCTIVITY*
%CH

8.9

8.4

8.4 \

7.9

8.2

INDUSTRIAL PRODUCTION

1.116
-28.3

1.104
-4.5

1.142
14.6

1.175
12.1

1.205
5.1

1.230
8.6

1.255
8.4

1.151
7.9

1.254
9.0

1.243
-0.9

1.134
-8.7

1.220
7.6

MONEY SUPPLY
%CH

282.6
0.6

287.8
7.6

292.9
7.2

294.7 \ 298.Oh% 303.5
2.4 V 4.6 )
7 6
'

308.0
6.1

312.5
6.0

245.6
6.4

263.3
7.2

277.7
5.5

289.5
4.3

305.5
5.5

INCOME VELOCITY OF MONEY
%CH

5.072
-2.7

5.074
0.2

5.219
11.8

5.339
9.6

5.389
3.8

5.458
3.8

5.507
3.7

4.768
4.3

4.961
4.0

5.066

5.176
2.2

5.440
5.1

NOTE:

PRODUCTIVITY

1.190
5.2

5.407
1.3

IS CALCULATED AS CONSTANT DOLLAR GNP PER WORKER;


li
http://fraser.stlouisfed.org/
P^FTAX PROFITS M I W S
Federal Reserve Bank of St. Louis

INVENTORY PROFITS
N

PROFITS FOR 75:4 ARE ESTIMATES

2.1

ECONOMIC OUTLOOK
ACTUAL
75:1

PAGE 3

FORECAST
ANNUAL ANNUAL ANNUAL ANNUAL ANNUAL
1972
1973
1974
1975
1976

7 5 : 2 7 5 : 3 7 5 : 4 7 6 : 1 7 6 : 2 7 6 : 376:4

INTEREST RATES
S&P COMP. AAA BONDS

8.000

7.263

7.557

8.250

8.630

8.150

7 . 3 2 7 . 5 6 7 . 5 8 6 . 5 0 6 . 7 5 7 . 0 0 7.50

5.25

8.02

10.80

7.86

6.94

6 . 5 6

5.92

6.67

6.12

5.25

5.75

6.50

7.00

4.73

8.15

9.84

6.32

6.13

AUTO SALES 1)

8.3

7.9

9.1

9.1

9.1

9.1

9.9

10.2

10.9

11.5

9.0

8.6

9.6

DOMESTIC

6.6

6.3

7.4

7.8

7.8

7.8

8.4

8.7',

9.3

9.8

7.6

7.0

8.2

I

1.6

1.8

1.4

1.6

1.4

2.361

2.047

1.337

1.173

1.612

PRIME RATE
COMftERCIAL PAPER 4 - 6 M T S .

IMPORTS

HOUSING STARTS 1)

8.610
8.98

1.7

0.995

8.610

1.6

8.670

1.7

8.630

1.3

8.400

1.3

1.3

8.000

1.5

1.5

1.068 1.258 1.372 1.500 1.600 1.650 1.700

IN MILLIONS OP UNITS—SEASONALLY ADJUSTED ANNUAL RATES




8.200

MONETARY POLICY, ECONOMIC EXPANSION
AND INFLATION

by
Kail Biunnci
Giaduate School of Management
University of Rochester
Rochester, NY 14627

Position paper for the Sixth meeting of the Shadow Open Maiket Committee (SOMC)
March 8, 1976




I.

Introduction
The sixth meeting of the Shadow Open Maiket Committee (SOMC) faces policy

issues involving important long-run consequences. The economic recovery initiated in
the second quarter of 1975 raised real national output in the second half of 1975 by
approximately 9% p.a. But the current prospects for the balance of 1976 aie somewhat
uncertain at this stage. Monetary growth dropped below the desired giowth path for
a lengthy period and possibly weakened somewhat the rate of recoveiy in the next quarters.
On the other hand it probably lowers also the inflationaiy pressures built into the system.
The appropriate couise of fiscal and monetaiy policy lequires serious examination
at this time. The SOMC directed in March 1975 (the fouith meeting) attention to the
longer-run consequences of a persistent budget deficit and warned in September 1975
(the fifth meeting) against the dangers inherent in activist financial policies. These
problems remain and their effects are reinforced by a widening uncertainty of the rules
of the game confronting the private sector. The pattern of policies pursued will crucially
determine whether our economy moves eventually towards gradual stagnation of real
growth accompanied by comparatively high unemployment rates and peimanent mfiation.
Some major trends in our budgetary and general economic policies point in this direction.
But fortunately we are not the victims of a deterministic process. The weight of probabilities always leaves a chance and this offers the SOMC an opportunity to raise a small
voice and hope.
The position paper is organized into five sections. The first section after the introduction examines recent monetary trends and considers the role of various factors shaping
monetary evolution. It also describes the relative role of velocity and government expendituies in postwar cyclic patterns and particularly in early recovery phases. The next section
discusses monetary policy, with particular attention to the pioblems emanating from the
Fed's internal procedures and mode of implementation. Some of the major questions
raised and assertions made by Fed officials in recent months are also considered. Section IV
evaluates recent monetary trends and submits a proposal foi the direction of monetary
policy this year. The last section attends to the piotracted issue posed by financial activism.




It outlines reasons for rejecting a policy conception which gradually emerged during the
1960's and still finds strong suppoit among influential groups.

n.

Monetary Trends
It is useful to leview the patterns of monetary evolution obseived in 1975. From

February 12, 1975 to February 11, 1976 the money stock grew at 5% and the monetary
base (from February 19, 1975 to Februaiy 18, 1976) by 7%. A rising currency ratio
and time deposit ratio lowered the monetary multiplier over the 12 months by about
2%. The average growth rate achieved over the year is remarkably close to the proposals
formulated by the SOMC in March and September 1975. The SOMC pjoposed at the
fourth and fifth meeting a growth rate of 5% to 6% centered on 5.5%. The SOMC
proposed however also on both occasions an immediate sharp mciease in the money
stock to a specified level in order to compensate the effects of monetary retaidations in
previous quarters. The "fiontloading" was almost achieved in the early spring last
winter. But its effect was gradually offset to some extent by the subsequent monetary
trends.
The average growth rate eventually achieved covers wide variations over shorter
intervals which reveal a fundamental problem in our policy institutions. The year opened
with a declining money stock which continued a receding pattern initiated in November
1974. The Federal Resetve authorities attributed the monetary contraction to a falling
credit demand caused by the lecession. The position paper prepaied for the fouith
meeting of the SOMC in March 1975 emphasized the crucial role of the Federal Reserve's
internal policymaking procedures converting a sagging demand for credit into a monetary
deceleration. Monetary contraction or deceleration is not the automatic result of
shrinking credit demand. It is produced by a policy proceduie geaied to an interest
target policy. The traditional implementation of monetary policy transferred the falling
demand for credit into last winter's monetary contraction. A policy procedure genuinely
addressed to monetaiy control could have prevented this development which remforced
at the time the ongoing recession.




TABLE 1

MONEY STOCK
BILLIOW
305

AVERAGES OF DAILY FIGURES
SEASONALLY ADJUSTED

OF DOLLARS

C

BILLIONS OF DOLLARS
305

1 1 I

1976
- JAN. 14

300 — F £ B -

Z\
28
4
It
16

BILLIONS
295.0
294.6
298.5
297.3
297.9

300

/TV

295

295

290

220

285

255

280

2C0

1 1

1 1 1111!

1 15 29 12 20 12
JAW
FES MAR

11 1

y 25 / 21
APR
WAY

LATEST DATA TLOTTED UECK EI^DIt^t

1 1 Mil
4 IB 2 16
JUN JUL
1975
FEHRUARY 1 8 ,

MM

I 1 1 \ 1 111!
U> Zl 10 24 0 22
AUG
SEP OCT

b 18
NOV

JLL

_LJJ.t

3 U 51 M ZX« 11 £2 to
DEC
JAN FEB
1976

1976

CURRENT DATA APPEAR I N TtfS BOARD Or COVERNOf^S* H.G RELEASE.
V1E MWEY STOCJ< CONSISTS OF DEMAND D£FOS|TS PLUS CURRENCY AND COIN HELD BY Th£




FUTLIC.

4

The contraction was succeeded by a sharp acceleration from the end of January to
the middle of March followed by an essentially constant money stock until the end of
April. A massive acceleration erupted in May receding rapidly into a low aveiage growth
from the end of May 1975 to the end of January 1976. Monetary growth averaged over
this period about 2.6% p.a., which is only about half of the Federal Reserve's proclaimed
lower boundaiy for the desired growth path. The period of lethargic growth was interrupted by bursts of acceleration and intervals of substantial deceleration.
The reader will find additional information describing the patterns of shorter-run
acceleration and deceleration in 1975 in the tables 2 and 3. Table 2 describes peaks and
trouglis in monetary growth and the growth rate of the monetary base observed last year.
The growth rates reported describe changes between successive and non-ovei lapping four
week averages. The letardation of April is clearly visible. Monetary growth fell from a
peak of 10.3% p.a. in late Maich to slightly less than 1% p.a. by the end of April. The
subsequent acceleration m May carried monetary growth to 18.7% p.a. There followed
two decelerations separated by one more acceleration. The magnitude of the respective
accelerations and decelerations are summarized in table 3. We note that the accelciation
in May dominates the other two accelerations observed in 1975. Moreover, the following
deceleration of June/July 1975 also dominates the other thiee decelerations listed in
table 4.
One frequently leads that the monetary authorities possess little, if any control
over money stock and monetary growth. The financial press pursues this theme usually
offeied by Federal Reserve officials whenever monetary growth drifts substantially away
from the anticipated path. This theme is not particularly new. We can observe its regular
emergence at opportune moments over many decades. It appears unavoidable that some
basic facts of monetary processes must be elaborated and emphasized with patient
repetition. The determinants of monetary growth and the relative role of authorities,
public and banks were discussed on several occasions in previous position papers. These
discussions recognized the specific contribution made by the public's behavior expressed
by changes in the currency latio, the time deposit ratio or the bank's behavior revealed
by changes in the (adjusted) resetve ratio. It was also shown however that the monetary




Table 2:

The Magnitude and Timing of Extreme Values

in the Growth Rate of Money Stock Mi and Monetary Base
in 1975

B
% - Change

Date

% - Change

Date

10.3

3/26/75

12.4

3/26/75

.9

4/30/75

-1.6

5/21/75

6/11-18/75

18.5

6/25 and 7/2/75

2.0

8/13/75

-1.9

8/13/75

9.1

9/10/75

10.10

9/10/75

-4.9

10/15/75

1.9

10/22/75

11.2

U/26/75

16.3

12/10/75

-4.3

12/31/75

-10.3

1/21/76

18.7

All changes are computed between successive four week averages. The dates indicate the
last week of the forward lying four week period used in the comparison. The date 3/26/75
lefers thus to a comparison between the four week period ending 2/26/75 with the four
week period ending 3/26/75. Average lag of extreme growth in base behind extreme
growth in Mj: 1.1 week




authoiities affect the movements in monetary growth with a substantial margin. The
behavior of the authoiities (i.e. Fed and Treasury) is succinctly summarized by changes
in the monetary base.
Additional information bearing on the association between monetary growth and
growth rates of the base can be inferred from last year's observation. The reader is again
referred to tables 2 and 3 for this purpose. We note fust that the swings of the two series
for Mj and B are closely related both in time and in relative magnitude. The peaks and
troughs in monetary giowth lead the giowth rate of the base in the average over 1975 by
1.1 weeks. This lag is well within the interval of four weeks used to average the weekly
data. It should be noted here that the last deceleration of the monetary base initiated
in December 1975 and carried to January 1976 overstates the relevant deceleiation emanating
from the authorities'behavior. The contribution made by the adjusted leseive ratio increased
in late January to about 13% or 14% p.a. A portion of this increase should be added to
the contribution made by the base. The estimated net result of -19% p.a. is listed in
parenthesis below the unadjusted figme for the last observed retaidation. The data
presented in the two tables also disclose that countermovements of Mj and B occur
only foi a few weeks never exceeding the averaging period used for computations.
Acceleiations and decelerations in the monetary base are typically associated with
accelerations and decelerations in the base. We can thus safely expect that any pei sis tent
acceleration or deceleration of the base will eventually dominate the other deteiminants
reflecting the public's or the banks' behavior.
The emphasis on the monetary base and the behavior of the monetary authorities
does not imply that the public's behavior in the money supply process is iirelevant. This
behavior exeited an increasing effect in recent years. Pertinent information elucidating
some of the important facts is presented in table 4. The first pait of the table indicates
that the cmrency ratio contributed moie persistently and to a iaiger degree to monetary
retardation than the time deposit ratio. The range of variation in the contributions to
the slioiter-run movements of monetaiy growth obseived in 1975 were essentially similar
for both currency ratio k and time deposit ratio t. They both ranged fiom about - 6%
p.a. to approximately + 3% p.a. But the currency latio contributed less than half the




Table 3:

The Comparative Magnitude of Swings in the
Money Stock and Monetary Base

The decelerations in M^ and the

The sequence of accelerations in Mj

associated decelerations in B

and the associated accelerations in B

B

B
-9.4

19.6

20.1

-16.7

7.1

12.0

•14.0

16.1

18.2

•15.5




number of positive contributions noted for the time deposit ratio and almost one half
as many negative contributions below - 3% p.a. We also remark on the lower part of the
table that the positive and negative contribution to monetaiy growth emanating from the
public's behavior were not evenly distributed ovei the calendai year. All the (20) positive
contributions resulting from the time deposit ratio were concentrated among the first 31
weeks of the year. The same front period of the year also contains 7 out of 9 positive
contributions made by changes in the cunency ratio. Over the last 21 weeks both contributions were dominantly negative. The movements of short-term interest rates over
the year explains to a large extent the variations m the contribution of the time deposit
ratio. The behavior of the cunency contribution diverges on the other hand from typical
cyclic patterns obsei ved in the past and may reflect a sense of financial uncertainty.
A decomposition of the movements exhibited by nominal GNP yields further
information on the interaction between monetary growth, changes in velocity and
government expenditures. This decomposition is based on the formula

GNP = M V + G

where V expresses in this case monetary velocity lelative to private expenditure. Table 5
shows the contributions made to changes in GNP between successive six month periods
for each postwar recovery phase. The intervals begin with the last six month period showing
a decline in GNP or the period with the smallest positive change in nominal GNP. The
interval ends with the six month period showing the maximal increase in nominal GNP. The
data in table 5 clearly demonstrate the role of velocity over the recovery phase. Changes
in velocity contribute with one exception the largest component to the increase in GNP.
The exception was the recovery of the early 1970's. But the acceleration of GNP over the
recovery phase dominantly reflects without exception the acceleration of velocity. It is
particularly noteworthy for our purposes that the velocity increase obseived thus far in the
current lecoveiy exceeds all lecovery phases with the exception of the 1950 experience. The
acceleration of velocity exceeded in the current experience also all the previous observations
with the exception of the early part of 1950. The first six months of 1950 already showed,




Table 4:

The Relative Fiequency of Negative and Positive

Contributions Made by Currency Ratio k and Time Deposit Ratio t to
Short-Run Monetaiy Growth Patterns in 1975

The computation period contained 52 weeks. The growth patterns were computed
between successive non-overlapping four week averages. The successive computations
shift the two four week periods by one week forward in time.

Number of contributions made by
The currency ratio k

The time deposit ratio

9

20

negative: above - 3 %

29

22

at most - 3%

14

10

positive

The lange of contributions made by the currency ratio k and the time deposit t ratio
in 1975 is

for k:

- 6% to + 3%

fort:

-5.5% to+ 3.3%

Hie distribution of positive k and t contributions between the fiist 31 weeks and the
last 21 weeks

Number of positive contributions
k
the first 31 weeks

7

t
20

the last 21 weeks

2

none




10

Table 5: The Decomposition of the Giowth Rate in
Nominal GNP in the Recovery Phase to the Period with
Maximal GNP Giowth

1.

2.

3.

4.
\\

Periods
l'st recovery
I/49-IH/49
n/49 - IV/49
ni/49 -1/50
IV/49 - n/50
1/50 - in/50
2'nd recovery
HI/53 -1/54
IV/53-11/54
1/54 • IH/54
n/54 - IV/54
ni/54 -1/55
3d lecovery
II/60 - IV/60
IH/60 -1/61
IV/60-11/61
1/61 -111/61
11/61-IV/61
4'th recovery
HI/69 -1/70
IV/69-11/70
1/70 -111/70
H/70 - IV/70

m/70-I/71
5.

5'th recovery
in/74 -1/75
IV/74 - II/75
1/75 -111/75

GNP

- .6

Peicentages per annum
M
V
-.4
.5
4.3
5.8
2.4

-1.5
3.1
8.1
12.4
15.5

+1.2
-.2
-1.4
-.8
1.8

.7
1.3
2.5
3.3
3.2

.5
3.2
4.2
6.6
7.7

-3.0
-3.6
-1.9
-.6
.1

2.8
6.6
8.1
9.0

1.3
1.5
2.1
2.3
2.4

•2.8
-.1
3.0
4.1
4.1

1.3
1.4
1.5
1.7
2.5

4.2
5.3
4.9
6.1
9.9

3.3
4.5
4.7
4.7
5.6

-.3
.1

1.2
1.0
1.2
1.7
1.6

2.0
7.8

2.4
4.3
4.5

3.3

11.0
17.4
19.6
-1.8
.9
4.8
9.3

10.9
- .2

13.8

•1 0

-.3
2.7

•2.2

1.9
7.1

1.7
1.6
2.2

Remarks: the peiiod indicated with 1/49 -111/49 refers to the change from quarters I and II
of 1949 to quaiters III and IV of 1949. The decomposition is based on the formula
GNP = MV + G
where V is private spending velocity and G measures government expenditures on goods
and services.




11

before the outbreak of the Korean war, an increase in V of 8.1% p.a. over the second half year
1949. The anticipations unleashed with the outbreak of the war accelerated velocity further
by a large margin I The increase on V moved from 8.1% p.a. to 15.5% p.a. The further
increases in velocity beyond the tliird period of a recovery stayed for all the other iccovery
phases between 1.1 and 3.5 percentage points. But a substantial further increase in velocity
from the second half of 1975 to the first half of 1976 and into the second half of 1976
depends at least partly on the monetary growth path permitted or puisued by the Fedeial
Reserve Authorities. It is not very probable at this stage that a retardation of monetary
growth from the second half of 1975 to the first half of 1976 and a lowei contribution of
M to the growth of GNP would be offset by a sufficiently large further increase in velocity
over the first and second half of the current calendar year. The probabilities weighing the
course of velocity associated with the different paths of monetary growth strongly suggest
a conservative pattern of monetaiy policy along the lines suggested by the SOMC.
This issue will be covered however in more detail in sections IV and V of the position
paper. The final paragraph of section II examines several statements made by Chairman
Burns at the occasion of recent Congressional Hearings. The statement presented on
February 3, 1976 discusses the low level of monetary growth observed since June. The
Chairman attributes this observation to a change in "regulation issued by the banking
agencies last November." This change "enables partnerships and corporations to open
savings accounts at commercial banks in amounts up to $150,000." The Federal Reserve
Authorities investigated the effect of this regulatory change and Chairman Burns notes
that "by January 7 around §2 billion had already been moved into these new accounts.
Since the bulk of these funds probably were held previously as demand deposits, this
shift in deposits has undoubtedly accounted for a significant pait of the weakness of Mj
in late 1975 and early this year." An examination of the short-run decomposition of
monetary growth between successive moving four week periods indicates an increase in
the negative contribution made by the time deposit ratio during December 1975. It is
noteworthy however that this contribution fell even lower (algebraically) in October and
over a somewhat longer interval. Moieover, the contribution resulting from changes in
the time deposit ratio aveiaged beyond the comparison period ending with the first week




12

of January at around -1.1% p.a., an amount about one fourth of the average contribution
in October 1975 before the regulatory change. We also note that the contribution made
by the base, or more appropriately for this period, by the sum of the contributions made
by base and adjusted reserve ratio, declined from late November to late January. The
regulatoiy change piobably raised the time deposit ratio somewhat and retarded monetary
growth tliis winter to some extent. But the order of magnitude involved is small compared
to the variations in the contnbiition to monetary growth attributable to the Federal Reserve
Authorities. The statement quoted thus directs attention away from the crucial determinant,
viz. the behavior of the monetary authorities.
Chairman Bums also notes the bulge in monetary growth which occurred in May/June
1975. This bulge is attributed to the Treasury's management of funds. Most of the
variations in Treasury balances occur with the Treasury's deposits at the Federal Reserve
Banks. Changes in Treasury balances thus immediately affect the monetary base.
Chairman Burns essentially argues that large amounts of "tax rebate checks and supplemental social security payments" were disbursed by the Treasury. Such disbursements
simultaneously raise deposits at commercial banks and the monetaiy base. The concurrent acceleration of the two magnitudes can be cleaily noted in table 1. The essentially similar order of acceleration for both M j and B also shows that the accelerated
injection of base money was rapidly diffused over the system and suggests that the
amplifying response occuried with comparatively small lag. Chairman Burns' description
how the bulge disappeared is particularly interesting in this context. We lead that
"the explosion of the monetary aggregates subsided as individuals disposed of their
additional funds," This is a most remarkable statement. It asserts that the money stock
declines or decelerates whenever individuals spend money. The bulge disappeared of
course as soon as the decline in Treasury balances, not offset by a decline in Federal
Reserve Credit was terminated. We should thus clearly recognize that the Federal
Reserve Authorities permitted the bulge to occur and were similarly responsible for the
subsequent retardation in the second half of 1975. But this aspect of our story should
be examined in the next section.




13

III. Monetary Policy; Targets and Procedures
Congress expressed early in 1975 an explicit interest in monetary policymaking.
The result of this interest was codified in House Concurrent Resolution 133 adopted by
Congress in February 1975. The importance of this resolution was discussed in the two
previous position papers prepared for March and September 1975. The Federal Reserve
Authorities were obliged by the resolution to present a target range of monetary growth
for a period of 6 to 12 months into the future. They announced in April a target lange
of 5% to 1VI% based on March 1975. The range has been widened m February 1976 to
AVi% to lxh% per annum. The target lange lemained thus fixed for almost a year and
Chairman Burns saw no reason in late summer 1975 to modify this range. But a growth
path is not fixed by its growth rate alone. The growth rate determines the slope, but
the position of the growth line still depends on the base chosen. The Federal Reserve
Authorities initiated the new procedures imposed by Congress with a base equal to the
data for March 1975. The resulting target cone is drawn in graph 2 attached at the end
of the paper. The broken line describes the actual path of the money stock since
January 1975. By June monetary growth pushed the money stock substantially above
the target cone. Monetary growth subsided beyond June and the growth path moves
across the target cone and drops after December below the range targeted in April 1975.
This range was soon changed however. The base was shifted in early summer to the
average of the second quartei placed in graph 3 on the line indicating the montli of May.
We note that the monetary path drops in October below the target range and falls
beyond Novembei even further below the desired growth pattern. The early February
data indicate a minimal shortfall of about $3.5 billion m the money stock. Relative to
the early February data the money stock would have to grow fiom February to March
by at least $6.5 billion in Older to satisfy the policy targets deemed appropriate by
Chaiiman Burns late last summer. But the base was again shifted in the fall. It was
moved from the second quarter to the third quaiter. The result is depicted in graph 4.
One single month lies now within the desired target range. And the last shift in basis
to the fourth quartei 1975 barely impioves matters. All points of the path are far
below the policy cone.




14

At the last meeting of the SOMC preliminary data including August and the first
week ending in September weie just available. My position paper acknowledged at the
time that the monetary path moved beyond June quite appropriately according to the
Fed's announced target lange. The money stock was pulled back into the planned range
Witli six months more information available we note at this stage that the Federal Reseive
Authorities allowed the monetary path to drift across and even to diop below the target
range.
The relative short fall in monetary growth under the four different selections of a
basis made by the Fed and the SOMC's proposals advanced in March 1975 and reaffirmed
in the meeting of September 1975 is presented in table 6.

Table 5* The Minimal Increase of Mj from
February 1976 to March 1976 Required to Move the Path
into the Taiget Range m Billions of $

Fed Basis

March

2'ndQ

3

4.5

SOMC Basis

3'dQ
5

4'fli Q

March (= $290)

3. 5

8.7

The reader should be leminded that the SOMC proposed m March 1975 that the Fed
immediately raise Mj to $290 billion in Match and proceed thereafter at a giowth rate
of about 5.5% p.a. The frontloadmg policy implicit in the SOMC proposal explains the
compaiatively laige shoit-fall of Mj compaied to the Fed's policy programs. The SOMC
pioposed moieover in September that the money stock be raised by about $2.5 billion
within a month in order to move the monetaiy path into the SOMC's taiget range
proposed at the March meetings.




15

The persistent and substantial deviation of monetary evolution from the Fedcial
Reserve Authorities'progiams requires some attention. The actual performance is
particularly noteworthy when we read Chairman Bums' satisfied evaluation at the
Hearings of February 3,1976. "Since last spring, growth rates of the major monetary
aggregates . . . have generally been within the langes specified by the Fedcial Reserve."
Such satisfaction appears most remaikable. Chairman Bums attempts however to justify
the low rate of monetary growth observed since June 1975. The statement piepared for
the Hearings before the House Committee on Banking, Currency and Housing (February 3,
1976) attributes to a shifting money demand a major role. Chairman Burns explains
that "the relatively slow rate of giowth in money balances during recent months has been
watched carefully, and at times with consideiable concern, by the Federal Reseive.
. . . we have been inclined to view the recent sluggish rate of expansion in Mj as reflecting
the influence of various factors that are leducmg the amount of narrowly defined money
needed to finance economic expansion." This theme is elaborated on several occasions
in the Chairman's statement. We are informed that ccnumeious financial innovations
and regulatory changes have facilitated the process of economizing on the sums held
in the foim of demand deposits. These developments have included the spread of
oveidraft facilities in banks, incieased use by consumers of geneial purpose credit cards,
the growth of NOW accounts . . . the emeigence of money market mutual funds, the
development of telephonic transfeis of funds from savings to checking accounts and
the growing use of savings deposits to pay utility bills, moitgage payments and other
obligations." The regulatory changes opening savings accounts at commercial banks
to partnerships and corpoiations is added to this list by Bums. Some of these changes
indeed laise the opportunity cost of holding money balances for any given level of
yields and wealth, and otheis lower transaction costs. In either case money demand
may be loweied by these developments. But others, e.g. the NOW account, do not
involve "shifts in money demand" but the proper measuiement of monetary aggregates
A plausible description offeis of comse no assurance of relevant explanation. But
Chairman Bums lefers also to the econometric work undertaken at the Board. He notes




16

that "since the Iliiid quaitcr of 1974 . . . ((he money demand) equation (used at the
Boaid) has pcisistently and increasingly oveipicdicted Ihc amount of money demanded
by the public to finance liansactions." The shift in money demand is tints infened from
obscivations contradicting the Fedeial Reseive's piefetred hypothesis. Such infeiences
are of couise widely used and tlicy wcie alieady applied by Ihc Fed dining (he 1930's
in order to justify its position. The conflict between traditional beliefs, expressed by
the inherited Federal Reseive theory, and obseivations, was mleipicted

to leveal in

the 1930's the "breakdown of an oidcily world" 01 "that the wotld had changed."
Theie is of course an alternative inteipictation, viz. that the theoiy involved is pooily
designed and should be rejected. But we do have a pioblcm heic and the Fcdcial
Reserve's conjectme based on its econometiic woik descivcs some attention. It was
unfoitunately not possible m the shoit time available since the House Committee Ileaimgs
to examine the Fed equation and compaic its peiformance with alternative specifications
involving a diffeicnt lag stuictiue, long teim interest lates and possibly even equity yields.
I conjectuie that alternative specifications of money demand probably yield no suppoit
foi the Chairman's contention It would seem highly mappropiiatc lo justify a low rate
of monctaiy giowth, which deviates substantially fiom the planned path still found
acceptable late last summer, in terms of the lesiduals obtained fiom an essentially uninteicsted hypothesis. If the Fedeial Reseive Authontics Iiad initiated a systematic
examination and comparison of available money demand hypotheses and dominantly
found the same pattern we could ccitainly assign moie weight to their conjecture. But
we obseive no signs of such studies and Chanman Bums oflcis certainly no information
in this lespect. The leadei should also be lcmmded that scvciat ycais ago the Fed told
us a leveisc tale. When monetruy giowth spin ted in the spung of 1972 the Fed assured
us subsequently that money demand had mcieascd. A study picpaied by Michael Ilambiugei
and published in the Journal of Money, Ciedit and Banking (May 1973) found no
evidence of the contention made at the time The positive coirelation between assertions
of shifting money demand and obscivations of "unanticipated" oi "unplanned" monctaiy
giowth is peihaps the most lehable regularity in this context




17

Chairman Burns concludes his evaluation of changes in money demand with the
following comments* "However, since we could not be cnthely certain of out views,
we have taken steps recently to insuie thai the rate of monctaiy expansion does not
slow too much or for too long. During the past thiee months 01 so, open market policies
have therefore been somewliat more accommodative in the provision of leseives to the
banking system." The time profile of the monetary base shows however the following
pattern* The base increased fiom about $119 billion to about $120.5 billion duiing
November, moved between $120 billion and $121 billion duiing December, declined
to $119.5 billion by the middle of January and surged to $120 billion by February 10.
We can find no evidence of a more expansionary policy between the end of November
and the middle of January. The monetary base actually declined over this interval and
only increased after the middle of January. The obseivable lecord yields thus little suppoit
for the Chairman's contention. The Chairman may have been misled on this point by
the traditional misconception cultivated among Federal Reseive officials. This misconception follows from the indicative interpietation assigned to the movement of
short-teim rates, and most particulaily to movements of the Federal Funds late. This
interest rate drifted from the beginning of November until the end of January downwards by about 50 basis points, the commercial paper rate by about 80 and the Treasury
bill rate by about 70 basis points. This drift was probably aitiibuted to the Fed's
"more accommodative policy." Actually the Fed's "accommodative policy" geared in
a traditional procedme to a short-run control over the Federal fluids rate tends to conveit
changing market pressmes on shoit-term rates into acceleiatioas oi decelerations of
the monetary base The falling market pressures between eaily November and the
middle of January were accommodatingly translated into a letardation of the monetary
base leflected by a deceleration of the money stock.
Chahman Bums also expresses substantial uncertainty about the measuiement of
the money stock. Such uncei tain tics do affect our judgment bearing on the desired
target path of measmed Mj, oi on the interpietation of the obseived taigct path relative
to the planned lange. The Chaiiman conjectmes in particular that bioader aggiegates
may be moie appiopriate foi monetaiy analysis and policy making in the future. This




18

may indeed be the case and the SOMC should share the Chahman's concern. But I
find it difficult to sympathize with the Chah man's position. The Boaid of Governors
of the Federal System has vast lesources at its disposal foi useful lesearch bearing on
non-contrived policy problems. There also exist Federal Resetve Banks with reasonably
competent research staffs. I see no evidence that the Boaid encourages these staffs to
examine an important issue foi policymaking. The clues available to an outsider seem
to reflect moie discouragement than cncouiagement m this lespect. The Committee
assembled by the Board to examine issues associated with the proper measurement of
the money stock may have finished its work. No lepoit is available so far and we cannot
judge the quality and the lelevance of the work performed. Once the leport is published
the SOMC will have more information to judge the substantive relevance of the measuiement problem. Repeated lefeiences to a measuiement pioblem may be valuable as a
political smokescieen They could be a memento of a substantive and possibly impoitant
pioblem. But that would be shown by the Boaid's investment of lesouices in a substantial
and prolonged examination of measuiement pioblems and the behavioi patterns associated
with the diverse monetary aggicgates quoted by Chairman Bums.
The variety of aiguments used by Federal Reseive officials to remove attention
fiom a paiticulai monetaiy aggiegate spans a consideiable range. We find in Chan man
Burns* statement piesented to the House Committee on Banking, Currency and Housing
on July 24, 1975 the following passage " . . . the narrowly defined money supply, Mj,
can actually be a misleading guide to the degree of monetary ease or lestiiction. For
example, in peiiods of declining economic activity both the transaction demand for
cash and the private demand foi credit will tend to weaken and thus slow the giowth
late of Mj." It is also noted that during economic downswings lower market rates
tend to raise the time deposit latio and to retard Mj still fuither. Seveial points
should be noted in this context. Falling money and credit demand affect monetary
growth essentially via the mteiest mechanism This interest mechanism operates on the
time deposit latio and the monetaiy base. The effect on the base is a consequence of
the Federal Reserve's interest target policy and would disappear with pioper monetary




19

control. Moieovci, the channel opciating via the tune deposit has been confined for
moie than 50 yeais to moderate propoitions compaicd to the joint influence of monetaiy
base and the behavior of the cunency tatio. Lastly, even rcpicsenting a highly endogeneous
monetary giowtli, still induced accelciations and deceleration of Mj, impose vaiiations in
monetary impulses fencing an accommodation of output in the shoiter-iun and pricelevels over the longei-run Such consequences cannot be cxcicised by the simple asciiption
of "endogeneity."

IV. What Happened and What Should Be Done
So what happened leally since Congiess passed HC133 and lequcstcd that the
Federal Rescivc Authorities attend moie effectively to co.Uiol monetaiy giowth? Oui
monetary authorities lesponded to some extent with the announcement of a planned
range of giowtli lates. The stability of this langc was made somewhat luclcvant with
the obseived instability of the base used foi computation Foui diffcient base values
have been used within one yeai. Tins means that contnuy to the idea expressed by
Congiess with IIC133 the Federal P^eseive Autlioiities effectively confine then operation
to a quaiteily progtam. This involves a substantial erosion of the longer-iun monetaiy
control and stability of monetaiy giowtli addiesscd by HC133 We also noted that the
actual path perfoimed pooily lelative to the targeted ian*je. This pciformance was
unavoidably accompanied by numeious explanations 01 justifications adducing appiopnatc
shifts in money demand, measuiement pioblcms or the inclevance of Mj We cannot
leject the possible ldcvance of this contention, but we should rescivc a substantial
modicum of doubt about these conjcctuics We should invite the Fedeial Rescivc to
foster an extensive lcsearch piogram at the Board (and even some Fedeial Reseive Banks)
attending to these questions. We should be icady and willing to be convinced — provided
such matenal is piesented in a competitive piofcssional context. But it seems prudent to
suspend these doubts and inteipiet the data to show some letaulation of monetaiy
giowth conflicting with the planned objective of the Fed and also conflicting of course
with the SOMCs pioposals made last Maicli and last Scptcmbei.




20

How do we explain this retardation relative to the planned objective? The basic
reason still lies in the internal procediues used to implement policy. This aspect has been
discussed many times in numerous contexts since we described the problem for the first
time in our joint report on Federal Reserve Policy-Making to the House Committee on
Banking, Currency and Housing in 1963/64. The problem results from an execution
of policy couched in terms of a short-run target for the Federal funds rate. The account
manager adjusts his daily (or houily) operations accoiding to the lelation of the market
rate with the targeted band. Whenever the maiket rate tends to drift below the target
band open market piuchases are letarded (01 sales increased), and a tendency to drift
above the target band induces increased open market purchases. The target band is of
course adjusted to changing market conditions. Such adjustments frequently lag behind
evolving events however and produce under the circumstances acceleiations (or deceleiations)
in the rate at which base money is injected into the system. Moieover the Federal Reserve
staff usually prepared profiles of Fedeial funds rates associated with desired or planned
paths of the money stock. This procedure was not so much used in recent years as an
instrument to implement an explicit interest target policy. It was presented as a device
to translate the monetary goals of the FOMC into operational standards for the account
manager. The experience since 1970 suggests however that this implementation procedure
endangers an adequate control of monetary growth. The attention directed towaids
monetary aggregates emerging in the early 1970's never involved a major change in internal
proceduies. It was simply integiated with the aid of translation procedures developed by
the staff. The problems typically associated with the inherited arrangement thus continued
in a possibly muted form. This issue remains particularly important as influential groups
inside and outside the Federal Reserve System attempt to move the Federal Reserve to an
explicit policy of controlling levels of selected interest rates. There aie some indications
wliich suggest that the Fed may shift the weight of attention somewhat further towards
interest rates.
The recent experience raises again a fundamental issue bearing on the quality of
monetary control. Chairman Bums emphasized in his statemend presented on July 24,1975
to the House Committee on Banking, Currency and Housing (he basic "imprecision"




21

of monetary control. Such imperfection certainly exists and will continue to plague us.
There remains however the question about the nature of this imperfection and the causes
shaping the degree of achievable contiol. The Qiairman properly refers to variations in
the public's behavior expressed by cunency and time deposit ratio, the changes in the
excess reserve ratio and shifts of deposits between member and non-member banks'
deposits. All these aspects contribute to lower the degree of control below perfection.
But Chairman Burns* list of problems affecting the degiee of control over monetary
growth is incomplete. Institution arrangements in various countries obstruct the achievable
degree of monetary control. We should note foi the USA in this context the specification
of reserve requirements, the prohibition of interest rates on demand deposits, and most
particularly the FOMC's internal procedures governing the making and implementation
of policy. It is for this reason that I include below proposals 2 and 3 originally advanced
in my position paper prepared for the Septembei meeting of the SOMC. Pioposal 1
tentatively suggests to the SOMC a course of monetary policy to be followed foi the balance
of the current calendar year.
1.

It is proposed that a portion of the accumulated short-fall of Mj be removed.

The money stock should be raised to about $299 or at most $300 for March 1975. This
would imply relative to early data for February 1976 an increase of Mj from February
to March by about $3 to $4 billion. The average increase of the monetary base required
for this purpose is approximately $1.2 to $1.6 billion. Beyond March the Federal Reserve
Authorities should hold monetary growth (determinedly) to a path of 5% per annum for
at least six months and probably to the end of this year. This proposal combines again a
measure of "frontloading" with an avowedly conseivative course followed subsequently.
The fiontloading is designed to offset the probably retarding effect of a low monetary
growth held over 7 months, and the modest growth rate for the balance of the year
should help to retard inflation gradually further.
2.

The shifting targets and the wide range admitted by the FOMC directs our

attention to the policy making proceduies. The SOMC should emphasize in my judgment
the importance of suitable modifications in the Fed's internal procedure. The FOMC
should be made responsible for the development of a useful targeting of monetary giowth.




22

This involves in paiticular the development of more leliable and more appiopriately
defined measures of the money stock. The Fed has recently enlarged the number of money
stock measures to eight. One wonders of course whether this is an attempt at obfuscation
to assure a sufficient supply of numbers. The larger the range of possible numbers available
for selection, the greater the probability that the Fed will find a number, ex post facto,
which fits its political purpose. This reservation associated with the manner in which the
numbers appeared should not distract us however from the fact tlaat a serious examination
of the measuiement problem is quite urgent. Some elements of current measurements
seem barely appropriate and poorly designed to yield the analytically desired measuie.
The SOMC should certainly await with great interest the findings of the special committee
instituted by the Board of Governors to review the measurement problem. In view of the
variety of measures listed by the Chairman of the Board and the sense of uncertainty
recently conveyed in this matter by an article in the Wall Stieet Journal, the SOMC should
explicitly state that the Fed be advised to assess systematically the relative usefulness of
the various measuies for purposes of monetary control and monetary policy. I would also
contend that we are not lost in a fog of diffuse uncertainty in this matter. We do possess
some information. No evidence has been submitted thus far to the profession that any
of the more inclusive measures beyond M2 offer useful information for purposes of
monetary control. The best measures still seem to center around M j and M2, and I
expect this situation to peisist. This does not mean that I expect the present measures
of Mj or M2 to be really adequate for our purposes. I suspect on the contrary definite
modifications of these measures once the Fed seriously proceeds to untangle the measurement problem.
The targeting of monetary growth forms the basis for the FOMC's determination of
the required giowth of the monetary base. This involves additional staff work under the
FOMC's responsibility. Hie required growth path of the base should then form the
centerpiece of the directive to the account manager. The responsibility for monetary
policy is divided in this manner in a specific way between account manager and FOMC.
The account manager is responsible for the growth path of the monetary base over a
specified interval of time. The discharge of this responsibility can be regularly assessed




23

by the FOMC. The latter, on the other hand, is made lesponsible for the choice of
monetaiy growth target and its translation into a taigeting range foi the monetaiy base.
The FOMC would also be responsible for the proper development of facilities and piocedures necessary for its assigned task* It appears to me that this division of responsibilities
would improve the Fed's policy making procedures.
3.

Lastly, the Federal Reserve authorities should be uiged to review the existing

arrangements and examine their usefulness for purposes of monetary control. I suspect
that numerous institutions, including the present manner of computing required reserves,
ceiling rates, etc., lower the controllability of the money stock. The FOMC should
immediately initiate a study systematically reviewing the institutional changes under
the Board's power which can be expected to impiove monetary control.

V.

The Protracted Issue
The last section of my position paper prepared for the meeting in September 1975

discussed basic and persistent issues with the "Keynesian establishment." Two major
alternative strands dominated professional thinking over many years. One view advocates
an activist exploitation jf fiscal and monetary instiuments in order to guide effectively
and in some detail the global couise of our economy. The other view cautions against
such activism and attributes a good part of the problems encountered in past yeais to
the longer-run consequences of such activist policies. It argues therefore for a set of
stable rules designed to confine economic fluctuations and changes in the price-level
to a tolerable margin The alternative views are again Ieflected in the proposals for
macro-policies debated since last summer. One group, centered aiound the Brookings
Institution, argues the necessity for a highly expansionist fiscal and monetary policy.
A large nominal expansion is desired in order to lower the unemployment to an
"acceptable" oi its natuial longer-run level. Moreovei, the large gap between potential
and actual output (or the actual and the natural late of unemployment) can be expected
to moderate inflation even in contexts of a laige nominal expansion. The SOMC on the
other hand approached the problem over the past three years in a substantially different




24

manner. It argues and still argues that a moderate and stable monetary giowth and a
substantially lower deficit should be the goal of our policies.
The differences between the proposals are immediately visible and easily recognizable.
It seems useful however to explore the background of these differences. Two fundamental
conditions shape the conflicting views. These conditions pertain to the degree of reliable
information about economic dynamics and the inteipretation of the government sector's
behavior. These basic differences deserve a fuller discussion at another occasion. This holds
in particular for the second aspect bearing on government. We note here only that the
activist thesis is essentially based on a public interest hypothesis of "government behavior."
It is assumed that legislators and bureauciacies will generally be guided in their actions
by an obvious public interest. This contrasts sharply with an entrepreneurial hypothesis
of the behavior of bureaucracies, legislative bodies and even courts of law. This thesis
states that legislators and members of bureaucracies compete in a maiket with programs
and proposals designed to optimize their long-run private interest. The alternative hypothesis
about the behavioi of political institutions crucially determine the approach to stabilization
policy. Adherents of a public inteiest hypothesis are usually inclined towards an activist
conception of policy, whereas advocates of the alternative view maintain the importance
of stable rules confining an essentially unstable political piocess yielding "stabilization
policies" as an essentially haphazard side-product of the competitive political game.
The information problem and the inherent uncertainties confronting us aie the
second major conditions affecting the differences in policy conception. This aspect may
be elaborated in terms of the standard analysis used by the profession and couched in
teims of the IS-LM diagiam presented in figure I. The vertical axis measuies the




F - line

-

line

25

rate of interest and the horizontal describes national product. The vertical F-line represents
full employment output and the horizontal i - line describes the inherited level of interest
rates prevailing in the economy. The LM-line describes the locus of (i, y) values equilibrating
money demand with money supply, whereas the IS line summarizes the locus of (i, y)
combinations equilibrating the output market. It seems to be argued that we know
the position of full employment F and oui cuiient position A We also "know," it
appears, that inflation rates fall at any position to the left of F. It follows that the best
policy combination relies on fiscal policy to move IS to the right and apply monetary
policy to hold interest rates constant until the IS line inteisects the F at the point E.
This policy implies of course a monetary expansion of some oidei, but the lesulting level
of monetary growth is baiely assigned much further significance in this argument.
We should have little doubt that all this could be done, possibly and maybe. But the
probabilities of a useful outcome are murky and the probabilities of a lepetition of the
increasing cycles of inflation and unemployment too large. The crucial condition of the
argument depends on the implicit assumption that we Imow at any time with a sufficient
measure of reliability the position of the IS line and its motion over the nearer future
(say up to one or two years). Should we possess such knowledge we indeed could
deteimine in some detail and reliably the time profile of policy. We would know when
to open the faucets and how to regulate the lunoffs and when to start closing some
faucets. The IS line moves however with a momentum determined by the system's internal
dynamics and this profile is not known with sufficient reliability. It is quite probable
that we open the faucets too much and too long. We simply do not know in sufficient
detail and with the reliability requiied the dynamic patterns involved. By the tune the
expansionist stance is modified the IS line may have a momentum carrying it substantially
beyond the desired position. Moreover, the subsequent reversal in policy introduces a
new range of instabilities into the system. These un certain ties are real and noncontnved
in my judgment. Any particular econometric model will give us of course a definite
answer to these questions. But the time piofile and orders of magnitudes of these answers
differ quite substantially between model. Moreover, we possess little evidence supporting
the cognitive claims of any particular econometric model. It appears thus wiser to admit




26

our lack of detailed information and pursue a stable longer-range couise designed to lowei
gradually both the inflation rate and the rate of unemployment. And most importantly,
this course (hopefully) adopted by the SOMC will pievent the ticnd towards evci incieasing
cycles of rates of inflation and unemployment experiences since 1965.
Two additional considerations reinfoice the geneial aigument outlined above. The
last section of the position paper prepared for the September meeting questions the
validity of the standard measures of the "potential gap" in national output. It is generally
acknowledged that external (or real) shocks substantially raised the inflation rate in
1974/75 for a time. But it would appear that these shocks also affect measiues of
potential output. One should wonder therefore whethei the usual measiues do not
exaggerate the actual "gap" in our resouice utilization. The lelevant occunence of real
shock effects on the level of potential output would disrupt over some period the operation
of "Qkun's law." It also implies that the unemployment rate would not be a good pioxy
of the "gap" appropiiately guiding the magnitude of nominal expansion. The non-vanishing
probability of a smaller gap leinforces the uncertainty discussed above. They are supplemented
with an additional question concerning the precise position of the veitical full output line
Lastly, the uncertainties encumerated in detail by Chairman Bums, beaiing on falling
(or lowered) money demand and measurement errors in monetary aggregates offei
additional reasons to move conservatively and avoid large variations in the course laid
out for monetary policy. These reasons, grounded in our unfortunate uncertainty,
determine the proposal submitted to the SOMC and formulated m the previous section.
One last aspect of the protracteq^s noteworthy at this time. It was suggested during
the debate on the appropriate course of "stabilization policies" last summei that a monetary
growth confined to 5% or 6% p.a. would probably abort or at least seriously endangei
the recovery. It was argued that a laige monetary expansion, piobably exceeding 10% p.a.
would be necessary in oider to support a viable upswing for 1975/76. We should note in
retrospect that the unfolding events eventually suppoited the SOMC's position in this respect
and suiely lefuted the expansionist statements made last summer.







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Men'S College

Bauer Center, Claremont, California 91711
Telephone (714) 626-8511
Applied Financial Economics Center

Memo to the Shadow Open Market Committee, for Meeting of March 8, 1976
From: A. James Meigs
Re:

Implications of Possible Monetary Growth Targets
The attached tables summarize the results of simulations run on a monetary

forecasting model at the Applied Financial Economics Center. The main objective
of this project was to indicate some of the relative costs and benefits of
various monetary policies that might be pursued by the Federal Reserve during
the period from fourth quarter 1975 through the fourth quarter 1977.
At the September 12, 1975 meeting of the Shadow Open Market Committee, we
recommended that the Federal Reserve should maintain the growth rate of M,
(demand deposits and currency) at a steady 5.5% annual rate. If this policy had
been followed, the average level of M, in the first quarter of 1976 would have
been $304.1 billion. Because the third-quarter to fourth-quarter rate was only
2.3%, the money stock would have to grow at an 11.7% annual rate from the fourth
quarter of last year to the first quarter of this year to reach the $304.1 billion
level. All of the simulations reported in this memo indicate that real GNP will
be lower in the first half of this year than it would have been with a higher
monetary growth rate in the fourth quarter of last year.
Table 1 assumes that the monetary growth rates of 1975 will be repeated
in 1976 and 1977.
Table 2 assumes that money growth will fall to a 2% annual rate in the first
quarter of this year and stay at that rate through 1976 and 1977.
Table 3 assumes that money growth will be maintained at a steady 4.5% annual
rate through 1976 and 1977. This is the new lower target rate reported by
Dr. Burns in his most recent report to the Congress.
Table 4 assumes that money growth will be maintained at a steady 5% annual
rate through 1976 and 1977.



Ciaremont Men's College
Memo to the Shadow Open Market Committee
for Meeting of March 8, 1976 - A. J. Meigs
Implications of Possible Monetary Growth Targets
Table 5 assumes that money growth will be maintained at a steady 7% annual
rate through 1976 and 1977.
All of the simulations assume that real Federal purchases of goods and
services will be held roughly constant, in order to focus the analysis on the
effects of monetary policies. There was no attempt to adjust fiscal policy to
counteract effects of the various monetary policies simulated, although some of
these effects probably would induce changes in fiscal policy.
The equations in the models were fit over the period from second-quarter
1953 through second quarter 1971 (to avoid distortions introduced by price-wage
controls after mid-1971.)
Conclusions:
1. If M-. growth does not accelerate from the fourth-quarter '75 rate of
2.3%, or if it declines further, the rate of growth of real GNP would be sharply
reduced within this year. This is illustrated in Table 2, which assumes a 2% M-j
growth rate for all of '76 and '77. In this model, a 2% M-j growth rate would
mean no growth in real GNP from first-quarter '76 through second-quarter '77,
unless the monetary deceleration were offset by other forces in the economy. The
2% M-| growth rate would have the benefit of putting substantial downward pressure
on the inflation rate, bringing the GNP deflator to a lower level by the end of
1977 than would any of the other monetary policies simulated.
2. It is, of course, highly unlikely that the Federal Reserve would maintain
such a low growth rate for M, for more than a brief time, expecially if symptoms
of recession were to appear. Table 1 illustrates a policy of repeating the 1975
pattern of monetary growth rates, with a quarter of low growth followed by two
quarters of much greater growth and a final quarter of low growth. From fourth
quarter to fourth quarter the assumed compound annual rate of growth is 4.4%.



Claremont Men's College
Memo to the Shadow Open Market Committee
for Meeting of March 8, 1976 - A. J. Meigs
Implications of Possible Monetary Growth Targets

3.

This policy apparently would avert the recession, implied by a steady 2% monetary
growth rate, although it would produce wide swings in quarterly growth rates of
both nominal GNP and real GNP. It also would continue to push the inflation rate
down, to a level of around 4% per year during 1977.
3. The anti-inflationary benefits of the 1975 pattern of monetary growth
rates could be produced also by a steady 4.5% annual rate of M-, growth with less
variation in quarterly changes in GNP. The fourth-quarter-'77 levels are almost
identical under both sets of money-growth assumptions.
4. The higher M^ growth rates simulated--5% and 7%--do increase the growth
rates of real GNP. However, they also raise the inflation rate. The 7% M-. growth
indicates substantially higher interest rates in 1977 than would result from the
lower monetary growth rates. This is partly because money-supply growth rates
influence inflation expectations directly in this model. The 7% money-growth
rate would be interpreted by lenders and borrowers as a sign that inflation
would be rising again in 1978, even though the inflation rate had risen very
little in '77.
5. The growth rates for real GNP in all of the simulations are disappointingly low. I don't know why that is so. It may be that the equations underestimate the growth of income velocity, because they were fit over the period
mid-'53 to mid-171 and so do not reflect more recent experience. Nevertheless,
they do indicate velocity growth of more than 3% per year, which is not low by
past standards. The large rise in velocity from second-quarter '75 to fourthquarter "75 occurred over too brief a period to be taken as evidence of a new,
higher trend-rate of velocity growth that can be relied on to persist. The slow
growth in real GNP may also reflect the slowness of adjustment in the price level.




Claremont Men's College
Memo to the Shadow Open Market Committee
for Meeting of March 8, 1976 - A. J. Meigs

4.

Implications of Possible Monetary Growth Targets
During 1975, the inflation rate fell to the trend-rate indicated by the deceleration
in money growth after mid-'73. Part of the *73-'74 rise in the price level,
furthermore, was a one-time upward step produced by the removal of price controls,
the devaluation of the dollar, and the increase in energy prices. Reductions in
the inflation rate may be slower from here on.
6. Behavior of both velocity and prices may be more favorable to the
prospects for growth in real GNP than these simulations indicate.

And the recent

deceleration in growth of Mp (demand deposits plus time deposits other than large
CDs plus currency) may partially compensate for a slowing in growth of M-,.
However, I do not think we should view a substantial deceleration in the growth
of M, as something that can be safely ignored. From first-quarter '71 to secondquarter '74, M, grew at a 6.9% annual rate. The deceleration to a 2.4% annual rate
of M, growth from second-quarter '74 to first-quarter '75 certainly contributed
to the severity of the recession, if it was not the primary cause. The very high
8.9% and 7.1%-monetary growth rates of the second and third quarters of '75 surely
contributed to the recovery from the recession directly and through inducing a
rise in velocity in the fourth quarter. A 7% M1 growth rate clearly is too high
to be consistent with continuing reduction in the inflation rate. But I believe
that too low a rate of monetary expansion in 1976--2% per year for instance-would raise a serious risk of recession.




IMPLICATIONS OF MONETARY GROWTH TARGETS
Table 1
Actual

1975 Money Growth Rates

1975
1

Mi (bil $)

283.0

AMi (% arm. rate)

GNP (bil $)

-0.3

1434

AGNP (% ann. rate)

Real GNP (bil 72$)

AReal GNP (% ann. rate)

GNP Deflator

(1972=100)

-2.1

1159

-9.2

XI

289.1

8.9

1461

7.7

1168

3.3

i976

III
296.1

7.1

1528

19.9

1201

12.0

IV
295.8

2.3

1572

12.0

1216

4.9

123.7 125.0 127.2 129.3

j
295.6

-o.3

1591

4.9

1216

0.1

n
302.0

8.9

1620

7.8

1224

2.6

1977
I Z I

I V

307.2

308.9

7.1

2.3

1658

1690

9.7

7.9

1238

4.6

1247

3.0

i
308.7

-0.3

1713

5.6

1249

0.6

ii
315.4

8.9

1747

8.3

1259

3.3

in
320.8

7.1

iv
322.7

2.3

1790 1825

10.0

8.2

1274 1283

4.9

130.8 132.3 133.8 135.3 136.6 138.0 139.4

140.8

7.8

4.3

7.1

6.8

4.8

4.6

4.7

4.4

4.0

4.0

4-6 mo. Comm. Paper Rate (%)

6.56

5.92

6.67

6.12

4.87

4.73

4.87

5.21

5.34

5.28

5.44 5.67

AAA Long-term Corporate
Bond Yield (%)

8.71

8.87

8.91

8.81

8.38

8.48

8.62

8.54

8.33

8.55

8.76 8.65

ADeflator

(% ann. rate)




4.2

2.8

4.1

IMPLICATIONS OF MONETARY GROWTH TARGETS
Table 2
Actual

2% Mi Growth Assumption

1975
Mi (bil $)

AMi (% ann. rate)

AGNP (% ann. rate)

Real GNP (bil 72$)

1977

I
283.0

II
289,1

III
296.1

IV
295.8

I
297.3

II
298.7

in
300.2

IV
301.7

I
303.2

II
304.7

III
306.2

IV
307.8

-0.3

8.9

7.1

2.3

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

1434

GNP (bil $)

1976

-2.1

1159

1461

7.7

1168

1528

19.9

1201

1572

1594

12.0

1216

1614

5.7

1219

1634

5.1

1218

1651

4.8

1218

1670

4.6

1691

4.7

1218

1713

5.0

1218

1737

5.4

1219

5.7

1222

1225

AReal GNP (% ann. rate)

-9.2

3.3

12.0

4.9

0-9

-0.1

-0.2

-0.1

0.1

0.4

0.8

1.1

GNP Deflatfl^ (1972=100)

123.7

125.0

127.2

129.3

130.9

132.3

133.6

134.8

135.9

137.0

138.0

138.9

(% ann. rate)

7.8

4.3

7.1

6.8

4.9

4.4

4.1

3.7

3.3

3.1

2.9

2.8

4-6 mo. Comm. Paper Rate (%) 6.56

5.92

6.67

6.12

8.71

8.87

8.91

8.81

AAA Long-term Corporate
Bond Yield (%)




4

-88

8-47

4

-78

8.23

4

-63
8.03

4

-50
7.90

4

-31
7.77

4

-lx
7.65

3

-91
7.52

3

-71
7.37

IMPLICATIONS OF MONETARY GROWTH TARGETS
Table 3

Mi (bil $)
(% ann. r a t e )
GNP ( b i l $)
AGNP (% a n n . r a t e )
Real GNP ( b i l 72$)

283.0
-0.3
1434
-2.1

1159

Actual

£>

1975

^ *0

II
III
IV
289.1 296.1 295.8
8.9
1461
7.7

7.1
1528
19.9

1168

1201

2.3
1572
12.0

x/2% Mi Growth Assumption

4

1976

II
299.1 302.4
4.5
*16OO
7.2

1216\ % 1223

4.5
1629
7.5

1977

III
305.7
4.5
1659
7.7

II
III
IV
IV
309.1 312.5 316.0 319.5 323.0
4.5
1690
7.7

4.5
1722
7.8

4#5

1755
7.9

1230

1238

1247

1255

1264

4-5

4#5

1790 1824
8.0

8.0

1273 1281

AReal GNP (% ann. r a t e )

-9.2

3.3

12,0

4.9

2.4

2.3

2.6

2.8

2.8

2.8

2.8

2.6

GNP DeflatfiM (1972=100)

123,7

125.0

127.2

129.3

130.9

132.4

133.9

135.3

136.7

138.1

139.5

140.9

ADeflatiSStf (% ann. r a t e )

7.8

4.1

4.1

4.3

7.1

6.8

5.0

4.7

4.6

4.4

4.2

4.1

4-6 mo. Comm. Paper Rate (%) 6.56

5.92

6.67

6.12

4.90

4.95

5.06

5.23

5.37

5.48

5.58 5.63

8.71

8.87

8.91

8.81

8.63

8.55

8.51

8.55

8.59

8.62

8.66 8.65

AAA Long-term Corporate
Bond Yield (%)




IMPLICATIONS OF MONETARY GROWTH TARGETS
Table 4
Actual

5% Mi Growth Assumption

1975
I
283.0

Mi (bil $)

AMi (% ann. rate)

-0.3

1434

GNP (bil $)

AGNP (% ann. rate)

-2.1

II
III
IV
289.1 296.1 295.8

8.9

1461

7.7

7.1

I
299.4

2.3

5.0

1572

1600

19.9 12.0

7.4

1528

1977

II
III
303.1 306.8

5.0

1631

7.9

5.0

1664

8.2

IV
I
II
III
IV
310.6 314.4 318.3 322.2 326.1

5.0

1697

8.3

5.0

1731

8.3

5.0

1766

8.4

5.0

5.0

1802 1839

8.4

8.4

1168

1201

1216

1224

1232

1241

1251

1262

1271

-9.2

3.3

12.0

4.9

2.7

2.6

3.0

3.3

3.3

3.2

3.1

2.9

(1972=100)

123.7

125.0

127.2

129.3

130.9

132.4

133.9

135.4

135.3

136.8

138.2

139.7

ADeflatiJBtf (% ann. r a t e )

7.8

Real GNP (bil 72$)

AReal GNP (% ann. rate)

GNP D e f l a t e *

1159

1976

1281 1290

4.3

7.1

6.8

5.1

4.8

4.7

4.5

4.4

4.3

4-6 mo. Comm. Paper Rate (%) 6.56

5.92

6.67

6.12

4.90

4.98

5.13

5.35

5.54

5.71

5.86 5.95

8.71

8.87

8.91

8.81

8

8*79

8.84

AAA Long-term Corporate
Bond Yield (%)




-65

8

-60

4.3

4.3

8.87

IMPLICATIONS OF MONETARY GROWTH TARGETS
Table 5
Actual

7% Mi Growth Assumption

1975
Mi (bil $)

(% ann. rate)

AGNP (% ann. rate)

1977

I

II

III

IV

I

III

IV

283.0

289.1

296.1

295.8

300.9

306.0

311.2

316.5

321.9

327.4

333.0

338.7

-0.3

8.9

7.1

2.3

7.0

7.0

7.0

7.0

7.0

7.0

7.0

7.0

1434

GNP (bil $)

1976

-2.1

7.7

1528
19.9

1572
12.0

1605
8.7

1644
10.0

in

1686
10.7

iv

1731
11.0

I

1777
11.0

II

1823
10.9

1870
10.7

1916
10.3

1168

1201

1216

1228

1242

1258

1276

1293

1310

1326

-9.2

3.3

12.0

4.9

3.9

4.7

5.4

5.7

5.6

5.3

4.9

4.2

(1972=100)

123.7

125.0

127.2

129.3

131.0

132.6

134.3

135.9

137.6

139.4

141.2

143.0

(% ann. r a t e )

7.8

4.3

7.1

6-8

5.2

5.1

5.1

5.1

5.1

5.2

5.3

5.4

4-6 mo. Comm. Paper Rate (%) 6.56

5.92

6.67

6.12

4.92

5.13

5.48

5.96

6.42

6.86

7.25

7.55

8.71

8.87

8.91

8.81

8.78

8.87

8.99

9.20

9.40

9.60

9.79

9.94

Real GNP (bil 72$)

AReal GNP (% ann. rate)
GNP D e f l a t e s

AAA Long-term Corporate
Bond Yield (%)




1159

1461

II

1340

3/1/70

BRIEFING FOR THE SHADOW OPEN MARKET COMMITTEE MEETING
March 8, 1976
by
Wilson E. Schmidt*
The reform of the international monetary system is now virtually complete•
Upon the approval of parliaments* floating will be legalized in the Articles
of Agreement of the International Monetary Fund. The United States Government is on the verge of wiping out the concepts and the measurement of the
balance of payments surplus and deficit, a move strongly recommended by
this committee. The balance of payments will no longer be a problem.
This is not to say that the reform is wrapped up. One problem for
example is the possible threat that a powerful interest group, the multinational corporations, may press, through no fault of its own, for return
to some form of the old international financial system or increased central
bank intervention.
The formal part of the reform was achieved in two meetings, one at
Rambouillet, France where six countries participated and the other in Kingston,
Jamaica attended by the Interim Coinmittee of the Board of Governors of the
International Monetary Fund. The product of the meeting was a proposed
Article IV which, without mentioning floating, legalizes it. Since President
Ford was attacked by flies in Rambouillet and the hotel in Kingston was named
The Pegasus, this article will surely be called the Horse-Fly Consensus.
The key paragraph in the Article says "Under an international monetary
system of the kind prevailing on January 1, 1976, exchange arrangements ir«ay

^Professor and Head, Economics Department, Viroinia Polytechnic Institute
and State University; Deputy Assistant Secretary, U. S. Treasury, 1970-72.




include • . . other exchange arrangements of a member's choice/1 The proposed
article does permit the introduction of a widespread system of "stable but
adjustable par values.11 But this requires an 85% vote, which gives the
United States a veto because we will have about 20% of the votes.
In settling on the new article, some important agreements were apparently
reached, particularly between the French and the Americans. That the two
agreed may itself be important because it may bring some peace to future
meetings in international forums, which seems to be what other nations had
in mind when they pressed the pair to settle their differences. Billed by
the press as a compromise of the French and American positions* it appears
to be more a French surrender.
There appears to have been agreement at Rambouillet on the economics
of stable exchange rates: If countries stabliiize the underlying economic
conditions, stable exchange rate? will be the derivative. To this end,
more consultations among countries are to be arranged, presumably leading
to more coordination of policies.
This makes good sense in terms of economics. But there is increasing
evidence that we live in a world of the political business cycle. In its
narrowest form, this says that politicians in power will increase government spending as their reelection date approaches and reduce it thereafter.
If correct, consultation and coordination will fail to produce stable rates
unless elections are set around the same date at least among the major powers.
The idea of increased consultation may seem superfluous given the
frequent consultation amoung central banks that has prevailed for years.
But what is new is that the increased consultation will be among ministries
of finance. Since information is ammunition in bureaucratic battles, the




U, S. Treasury Department will presumably find its position strengthened.
Though some may object that this introduces a greater political element
into intervention policy, it seems likely, for the present, to portend
less U. S. intervention in foreign exchange markets and perhaps that of
other central banks as well.
There also was agreement at Rambouillet that central bank intervention
shall only be to avoid disorderly market conditions or erratic fluctuations
in exchange rates. Each country will be its own judge whether such conditions prevail. Central banks are not supposed to resist fundamental factors,
This has been U. S* policy —

whatever it means. Unfortunately, these

elusive terms remain undefined. But it is a relief to know that Rambouillet
did not include a consensus on target or zone rates for exchange rates as
originally planned in June Ib74.

The recent experience with tho Italian

lira shows how miserably intervention can fail. And it is important that
the Fed and Treasury are apparently agreed that interest rate differentials
among countries are considered fundamental factors so that intervention to
offset exchange rate movements induced by them is presumably precluded.
All this raises doubts about the view, as expressed in some press stories,
that Rambouillet would lead to more central bank intervention.
Unfortunately, the legalization of floating cost us something
which of course is not surprising since it is the result of carefully
balanced international agreement. Twenty-five million ounces of gold in
the International Monetary Fund will be sold over a period of four years
by the Fund with the profits transferred to the less developed countries.
Our share of that gold, had it been returned to the members in proportion
to their quotas (as will be the case for another 25 million ounces) so we




could sell it at home or abroad would be 5,4 million ounces which at present
prices would be worth about $700 million.
The sale of gold is part of the U. S. effort to get gold out of the
system. Under the agreement the Fund cannot buy gold without an 85% vote.
And the Fund won't knowingly sell gold to central banks. Central banks
agreed not to peg the price of gold. Whether central banks will buy gold
in the private market remains to be seen.
The world may also have paid a price in terms of future inflation.
The agreement will expand the quotas of the members in the IMF by about
$11.7 billion* a sum equal to more than 5% of present reserves. While
this impact awaits ratification* the Fund has announced its willingness
to increase its lending by AS% on the seme criteria it has used in the
past until the increase in quo .as is idtified* While there is no mechanical
relationship between quotas, lending policies, and reserves, it is obvious
which direction the world price level moves as a result of this.
The agreement calls for the continued study of a substitution account.
Whether it is for gold or for dollars or both is not yet clear. If it is
a device by which central banks can exchange their gold for SDRs at the Tund*
it is essential that the Fund be ordered to sell the gold so that it may be
used for private purposes rather than be locked up in the Fund's vaults.
If it is a device by which central banks can exchange their dollars for SDRs
at the Fund, then American agreement to the scheme would be unpatriotic;
after all, we gain seigniorage by virtue of printing the money the world
uses.
Until recently, it has been quite clear that the business community of
the United States was quite content with the floating rate system now beinq




ratified* For example, in a recent poll, the National Association of
Business Economists found that 83£ of its responding membership preferred
floating to fixing. But in December a group of accountants, the Financial
Accounting Standards Board, decided upon a rule which could induce multinational corporations to oppose floating. It decided that exchange rate
gains and losses, whether realized or not, should be reported in currentprofits or losses. (Heretofore, there was no hard and fast rule.) Specifically* virtually all liabilities of a foreign affiliate of a parent American
corporation should be reported at the current exchange rate for the dollar
when the parent consolidates its return. Likewise, all assets should be
reported at current retes of exchange except fixed assets (for which the
historic rate will be used) and inventories (Tor vJiich a historic rale or
current rate will he used),

mis tppj^s to insure that when ti.e dollar

depreciates on the foreign exch-ngj ruirket the multinationals as a group
will show losses that are unrealised beeouse liabilities subject to the
depreciated dollar rate will exceed assets subject to the some conversion
rate.
The problem this creates is obvious. If one assumes that the officials
of multinationals are risk-averse, they will become discontented with
fluctuations in the exchange rate. That is, while they might like the
paper profits that an exchange rate appreciation brings, they will dislike
even more the paper losses acconpanying depreciation. As a consequence they
may press for more stability (fixing) cf rates. There is growing evidence
of this (Business Week, January 26, 1976). Of course fixinq would not be
in their long run interest; it was the fixing of exchange rates which led to
the U. S. government controls on private foreign investment in the 1960*5.




Fortunately* this need not be a problem unless the multinationals
want to make it a problem* There is considerable evidence that changes in
accounting techniques, such as a switch from U F O to FIFO, which do not
change underlying economic facts have little or no impact on stock prices.
[A summary of the literature appears in Thomas R Dyckman, tt« a1>,EfPicicnt
Capita1 Harkets and Accpuntino, (Englewood Cliffs: Prentice Ha11 * 1975).
Apparently the market figures out what is real and what is unreal. If
the multinationals come to understand this, 1hey won't press for more exchange
rate stability which in the end will load to their control by the Federal
Government•




Comments on Past, Current, and Future
Fiscal Policy Developments
Robert H. Rasche
Michigan State University
February 26, 1976

In the various summaries which I have prepared for past
meetings of this Committee, I have attempted on several occasions
to summarize what has happened with respect to fiscal policy and
the implications of these developments for monetary policy*

I

must admit that I have not yet settled on a presentation with
which I am totally satisfied, and so I have tried yet another
format.

Tablel, with information on 1971-1975.3, represents an

initial step towards a hopefully comprehensive summary statement.
The first five columns on Table 1 present information from
the National Income and Products Accounts budget for the Federal
Sector.

These figures are on a seasonally adjusted basis, but,

at the risk of confusing everyone, I have stated them at quarterly
rates to make them comparable with the flow figures on the right
hand side of the table.

The story here is very much a continuation

of the post-Vietnam period.

In terms of its demand on the productive

resources of the economy, the Federal Government has shown virtually
no growth over the past five years.

This can be seen from the con-

stant (58) dollar figures on government purchases of goods and
services in column 2.

Second, transfer payments continue to grow

at an extremely rapid rate.

Prior to mid 1974 this was primarily

because of inflation; in the past year it has been a combination
of continuing inflation and high levels of unemployment.




Finally,

0/

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73.

TABLE 1.—Assumed Values for Effective Reserve Requirement Ratios.




Years

Reserve Requirements

1891-1923

.08

1924-1933

.09

1934-1935

.10

1936

.15

1937

.20

1938-1940

.175

1941

.20

1942

.175

1943-1947

.15

1948

.175

1949-1950

.14

1951-1952

.16

1953

.15

1954-1957

.14

1958-1970

.13

Sources:
col 1-5:

National Income and Product Accounts, Survey of
Current Business, Tables

col 6-8:

Federal Fiscal Operations: Summary, Federal Reserve
Bulletin, p A32

col 9:

Federal Fiscal Operations: Summary, Federal Reserve
Bulletin, p A32: US Budget Surplus or Deficit Plus
Other Means of Financing, Net (Net Outlays of Off
Budget Federal Agencies, Plus Accrued Interest Payable, Plus Seigniorage.

col 10-11:

Federal Fiscal Operations: Summary, Federal Reserve
Bulletin, p A32:Selected Balances (End of Quarter Beginning of Quarter)

col 12:

Federal Fiscal Operations: Summary, Federal Reserve
Bulletin, p A32 Selected Balances - Other Depositories
(End of Quarter-Beginning of Quarter) + Other Cash and
Monetary Assets

col 13:

Consolidated Condition Statement of all Federal Reserve
Banks, Federal Reserve Bulletin, p A10, Total U.S.
Gov't. Securities (End of Quarter-Beginning of Quarter)

col 14:

(Col. 10 + Col. 11 + Col. 12 - Col. 9 - Col. 13)




—O_

as is well known, the pattern of Federal receipts has changed
drastically over the past year.

In previous years receipts had

grown quite rapidly because of the high income elasticity of
the tax laws; in 1975, the recession plus the adjustments to
the tax laws in late Spring (subsequently extended in December,
19 75) have caused a sharp V pattern in receipts for the year.
The result has been record deficits.
The center part of the table indicates the unified budget
account information and the recorded financing requirements.
Much of the difference between the financing column and the unified budget deficit column is the result of off-budget agencies
and accrued interest liabilities.

I have not yet attempted to

reconcile the financing column with the National Income Accounts
Deficit/Surplus column.

The reconciliation items fall into three

general classes: 1) difference of definition; to the extent
that there are definitional differences between the two, adjustments will be necessary to the financing column and the borrowing from the public column.

2) Timing differences; the National

Income Accounts Budget is primarily on an accrual basis, while
the financing column, with the exception of the interest accruals
is on a cash basis.

Again adjustments to the financing and bor-

rowing from the public columns will be necessary with government
accounts payable treated as short-term loans from the public
and government accounts receivable treated as short-term borrowing
from the public.

Finally 3) there will remain one reconciliation

item because asset transactions are not included in national income
accounting.

It should also be noted that the figures in the center

and to the right of the table are not seasonally adjusted.




-3In the absence of these reconciliations/ the financing requirements of fiscal policy, as measured by National Income
Accounts concepts is not accurately represented by the column
headed financing.

This column, however, can be allocated to

changes in cash accounts, borrowing from the Federal Reserve
System, and borrowing from the non Federal Reserve Public.
2
This allocation is indicated in the five right columns of Table 1.
The figures in these columns indicate that since the beginning
of 1971, the Federal Government has required approximately 115
billion of financing.

During this period of time, it has run up

its cash balances by approximately 15.6 billion, thus requiring
it to issue slightly more than 130 billion dolllars of debt.
Twenty-five billion, or slightly less than one-fifth of this has
been picked by the Fed.
In the first three quarters of 1975 the financing requires
amounted 54.5 billion dollars.

In addition, the Treasury in-

creased its cash balances during this period by 5.3 billion
dollars, so that total borrowing amounted to 59.8 billion dollars.
You may recall that one year ago we estimated that borrowing
for the period from the beginning of 197 5 through the end of
fiscal 1976 would probably be in excess of 100 billion, and
quite likely as large as 125 billion.

At this point, it would

appear that the available data are roughly consistent with
those estimates.

Of the 59.8 billion through the first three

quarters, 6.5 billion was absorbed by the Federal Reserve.
This indicates a considerable change in the Fed's behavior in
monetizing the deficit relative to the period 1971-74.

In those

four years, approximately 20 percent of the total borrowing was
absorbed into the Federal Reserve portfolio; in the last three



-4quarters for which the data is available only 9 percent of the
total borrowing was absorbed into the Federal Reserve portfolio.
Budget Projections
Two years ago projections about the future state of the
Federal government budget were rather hard to come by.
there are

Currently

numerous products to choose among; the problem

is to evaluate the product which is being pushed.

As in the past,

rather than attempt to generate a competing product of my own,
I shall attempt to evaluate some of these alternatives; in particular
those presented by the administration (O.M.B.) and the Congressional
Budget Office (C.B.O.).
All soothsaying regarding the Federal Budget is critically
dependent on the path of economic activity.

Two (not equally

valid) alternatives are currently in vogue.

The first, which I

shall call budget forecasting is distinguished by the use of an
implicit or explicit model which recognizes a simultaneous relationship between the outcome for economic activity and the
outcome for Federal receipts and outlays.

In this case the paths

of economic activity and the budget outlays and receipts are
mutually consistent forecasts, given "the assumptions regarding
the variables under policy control and other 'exogenous1 variables.
The second, which I shall call budget projection is distinguished
by the development of assumptions about the path of economic activity independent of fiscal policy parameters, and then uses the
constructed path of economic activity to derive projections about
the path of budget measures.

There is no presumption that the

path of economic activity would actually be realized if the fiscal
policy parameters were set consistent with the budget projections.




TABLE 2.—Economic Assumptions—O.M.B. Budget Projections.

A.

B.




1975

1976

1977

1978

1979

1980

1981

1498

1686

1896

2123

2353

2606

n.a.

794

832

879

936

997

1061

n.a.

January 1975
1.

GNP—Current $

2.

GNP—58$

3.

Percent Change
in CPI

11.3

7.8

6.6

5.2

4.1

4.0

n.a.

4. Unemployment Rate

8.1

7.9

7.5

6.9

6.2

5.5

n.a.

January 1976
1.

GNP—Current $

1499

1684

1890

2124

2376

2636

2877

2.

GNP—72$

1187

1260

1332

1411

1503

1600

1679

(GNP—58$)

(805)

(854)

(903)

(957) (1019) (1085) (1139)

Percent Change
in CPI

9.1

6.3

6.0

5.9

5.0

4.2

4.0

4.

Unemployment Rate

8.5

7.7

6.9

6.4

5.8

5.2

4.9

5.

Treasury Bill
Rate

5.8

5.5

5.5

5.5

5.5

5.0

5.0

6.

Corp. Profits

118

156

181

201

223

247

271

7.

Personal Income

1246

1386

1538

1727

1930

2138

2331

3.

Source

The Budget of the United States Government, Jan. 1975
2
The Budget of the United States Government/ Jan. 1976, pp.
25-26. Data for 1975-77 are forecasts of economic developments,
consistent with assumed path of fiscal and monetary developments,
Data for 1978-81 are mechanical projections which are not functionally related to derived value offiscal policy measures.




-5The O.M.B. economic assumptions are presented in Table 2.
The second part of the table indicates those presented with the
current budget document, and the corresponding projections from
last year are indicated in the first part of the table.

The

current estimates are true forecasts for the period through 1977;
thereafter they are projections in the senseof the above definitions,
Note that in terms on nominal GNP there has been essentially no
change in the O.M.B.forecasts through 1978.

On the other hand,

real output has been revised upward for this period; correspondingly
the inflation rate has been revised downward.

After 1978 the

O.M.B. projections have become more pessimistic on the decline in
the inflation rate than they choose to be a year ago.

The un-

employment rate is projected to fall slightly faster than was
assumed a year ago, but still is assumed to remain above five
percent through 1979.
The C.B.O. economic assumptions are presented in Table 3.
Two paths for economic activity are given; both are projections
in the sense of the above definitions; both are used to attempt
to evaluate the cost of the current services budget and the
revenues which would be raised under the present tax laws.
Path A is constructed so that it averages out to approximately
six percent real growth over the period through 1981; Path B
is constructed to average out at approximately five percent real
growth over the same period.

In real terms, Path A and the

O.M.B. projections get to approximately the same place at the
end of the period; the difference is that O.M.B. has faster real
growth in the initial years which slows down considerably in the
last few years of the projection period.

In real terms, the

Path A projection is not much different

from that prepared for




TABLE 3.—Economic Assumptions—C.B.O, Budget Projections.

1975

1976

1977

1978

1979

1980

1981

1460

1642

1852

2092

2323

2558

n.a.

2) GNP—58$

793

835

892

960

1023

1085

n.a.

3) Percentage Change
in C.P.I.

8.7

7.0

5.8

5.2

4.4

4.0

n.a.

4) Unemployment Rate

8.4

7.6

6.7

6.0

5.5

4.9

n.a.

1472

1675

119

163

1241

1390

1476

1695

1933

2205

2485

2780

3075

2) GNP—58$

796

856

916

980

1036

1085

1126

3) Percentage Change
in C.P.I.

9.2

7.2

7.1

7.0

6.8

6.6

6.6

4) Unemployment Rate

8.5

7.4

6.4

5.4

4.8

4.5

4.5

5) Treasury Bill
Rate

5.9

6.1

6.3

6.5

6.8

7.1

7.5

6) Corp. Profits

122

170

215

245

271

297

323

1242

1407

1608

1800

2014

2250

2490

1476

1675

1845

2050

2270

2500

2755

2) GNP—58$

796

847

880

922

968

1015

1065

3) Percentage Change
in C.P.I.

9.2

7.2

6.9

5.9

5.6

4.8

5.0

4) Unemployment Rate

8.5

7.7

7.5

7.1

6.7

6.3

5.9

5.9

6.1

6.3

6.5

6.8

7.1

7.5

122

163

188

205

226

250

275

1242

1390

1530

1700

1860

2045

2248

A) April 1975—Fast
Alternative
1) GNP—Current $

B) 2nd Concurrent
Resolution (12/12/75)
1) GNP—Current $
2) Corp. Profits
3) Personal Income
C)

Budget Projections
1/26/76 Path A
1) GNP—Current $

7) Personal Income
D)




Budget Projections
1/26/76 Path B
1) GNP—Current $

5)

Treasury Bill Rate

6) Corp. Profits

7) Personal Income

Source
1
1976 Budget: Alternatives and Analysed, Prepared for Congressional Budget Committees, April 6, 1975
2
1976 Congressional Budget Scorekeeping, Congressional Budget
Office, Dec, 1975 p. 3
Five Year Budget Projections Fiscal Years 1977-81, Congressional
Budget Office, Jan. 26, 1976, pp 4, 31, 45. Neither path is
functionally related to the derived value of fiscal policy variables. Path A is a projection at 6% average real growth; Path B
is a projection at 5% average real growth.




-6the Congressional Budget Committees last April; it shows somewhat faster growth in the earlier years, but comes out at the
same place by 1980.
The interesting discrepancies among these projections
concern the inflation rate represented here by the annual rate
of change in the C.P.I.

Path A of the C.B.O. shows virtually

no decline in the inflation rate over the entire projection
period (inflation declines from 7.2 percent in 1976 to 6.6 percent in 1981).

Even under the slower real growth assumptions of

Path B, the inflation rate declines slowly relative to the projections prepared for the Congressional Budget Committees a year
ago.

The administration seems equally pessimistic about declining

inflation through 1978, but then projects rapid declines through
1981.

In every current projection, the unemployment rate is

assumed to hang in the 5.5+ percent range at least through 1978.
In summary, it seems appropriate to conclude that the budget projectors are counting on a world of high and persistent
inflation and high and persistent unemployment in spite of real
growth rates which are assumed to be high by historical standards.
Defining the economic assumptions allows derivation of the
fluctuations in government receipts and outlays which are
essentially caused by the functioning of 'automatic stabilizers1.
In addition, it is necessary to define assumptions with respect
to discretionary action on expenditures and tax laws.

Congressional

Budget Office projections are all constructed on the basis of the
Current Services Budget.

On the outlay side, this means that

current programs are maintained in real terms; any erosion of
purchasing power is assumed to be made up through increases in
appropriations.



(Maybe this should be viewed as cost-plus as

-7constrasted with fixed-price budgeting).

On the tax side, it

assumes maintenance of the existing tax laws.

In the present

case, this means the assumption that the modifications to the
tax laws

which were enacted on a temporary basis last December

are assumed to be extended before July 1, 1976 for the remainder
of the projection period.

No one is trying to sell the current

services budget as a forecast of the path of the government budget.
Rather it is presented as a what if standard against which changes
resulting from Congressional action can be compared.

Unfortunately,

the system of presentation does not seem to allow for the separation
of the direct effects of congressional actions from the effects
through induced changes in economic activity.

A second unfortunate

side effect is that there appears to be the tendency in public
discussion to lose sight of the fact that these are not current
services budget forecasts, and to act as thought the projections
of outlays and receipts are highly probably outcomes for the future
which can be used to justify changes in the levels of programs
or provisions of the tax laws.

This kind of discussion is analagous

to that of the 'fiscal dividend1 of the end of the Vietnam war which
was popular during the late 1960's.

As Table 1 clearly indicates,

the 'fiscal dividend' never materialized because the economic envi raiment turned out to be different than the assumptions of the
'fiscal dividend' projections.
The O.M.B. combined forecast-projections take a considerably
different tack.

On the outlay side, the assumption is that pro-

grams will remain fixed in current dollar terms, except where
specific recommendations are made for changes in program levels
(mainly in defense), or where there are cost of living provisions
in program benefits or Federal pay scales, or where there will



-8be increased costs because of cost of goods purchased from the
4
private economy.
It would appear that these assumptions are
closely approximated by the statement that Federal purchases
of goods and services are assumed to be constant in real terms,
while transfers, with the exception of Social Security, are
assumed to be steadily declining in real terms.

Past congress-

ional behavior suggests that the latter assumption is wishful
thinking on the part of the administration.
On the receipts side of the budget, the administration's
projections include a specific tax revision program to be
effective on July 1, 1976.

The provisions included in the

assumptions involve:
1)

an increase in the personal exemption from 750 to 1000
dollars

2)

the substitution of a flat standard deduction (2500 on
joint returns; 1800 on single returns) for the long
standing percentage deduction and the low income
allowance introduced in 1975

3)

reduction in the personal income tax rates.

The budget

is vague on the details of the rate changes, but an
example is indicated in Table 4.
4)

reduction of the corporate income tax rate from 48 to
46 percent

5)

a tax credit of from 1.5 to 3.8 percent on interest
income from residential mortgages effective 1/1/77.

6)




temprorary high write-off's of real investment in high
unemployment areas (1/2 of useful life on structures;
5 year maximum on equipment)

Tax Liabilities for Famiiy with 2 Dependent^
Filing Joint with Itemized Decuctions of
16 Percent of Adjusted Gross Income
(If standard deduction exceeds itemized
deduction, family uses standard deduction.)
1976
Adjusted
Gross
Income

1972-74
law

$

$

o

5,000
7,000
10,000
15,000
20,000
25,000
30,000
40,000
50,000

Note:

5,000
7,000

:
:

98
402
886
1,732
2,710
3,820
5,084
8,114
11,690

1975 :
law :
$

0
186
709
1,612
2,590
3,700
4,964
7,994
11,570

Revenue
Ad^ustmert
Act
Extended *

Revenue
Adjustment
Act
$

0

$

0

268
797

135
651

1,642
2,620
3,730
4,994
8,024
11,600

1,552
2,520
3,6*0
4,904
7,934
11,510

:
Pres:dent's :
Proposal
:

1977
Presida
Propcs al

t

$

o
89
555
1

,446
2,405
3,507
4,781
7,799
xl,345

Effects oi the earned income credit are excluded. If this family were fully
eligible for the earned income credit, i.e., all 'vGI is earned income, then
the table rows would be:
$

98
402

-300
86

-150
218

-300

0
8J

Where a negative number is indicated, a rebate would be paid. These r e u s e s are
the budget as outlays rather than reductions m receipts.
Estimates r>ased on a hypothetical extension or the tax cats provided lor the first
6 months of 1976 by tne Revenue Adjustment Act of 1975.




0
60
49o
3 ,?25
2, 280
-,370
4, 648
7 ,664
180

f/s

e A c

Q

0
60
IL

-97)

increase in the combined employer/employee social
security tax rate to 12.3 percent from the present
11.7 percent effective 1/1/77

8)

increase in the unemployment insurance tax rate to 0.65
percent from the present 0.5 percent and the base to 6000
dollars of wages per annum from the present 4200 dollars
of wages per annum effective 1/1/77

Provisions 7) and 8) are projected to generate an additional 5.4
billion dollars of revenue during fiscal 1977.

The forecast -

projections of outlays and receipts for fiscal years 1976 through
1981 are indicated in Table 5.

Section C, with proposed changes

indicates the projections under the assumption that the above
tax program is enacted.

Section B f current programs is not

analagous to the Current Services projections of C.B.O. since
it assumes that the tax provisions which were extended last December will be allowed to lapse in July, and the tax law will revert back to the provisions in effect before May, 1975.
It seems highly probable considering that 1976 is an election
year, that some sort of tax revisions will be enacted which either
extend the current temporary provisions, or
very similar will be enacted.

something

Thus section B of Table 5 which

shows a decline in the deficit to less than 20 billion dollars
in fiscal 1977 is completely unrealistic.
The C.B.O. current services projections are given in Table 6.
Path A, which is constructed for six percent real growth is
probably not worth considering, at least in the later years, because it does not seem that that

rate of real growth is sustain-

able over that period of time (certainly not with the Federal
budget kept at current service levels), and I am unprepared to



TABLE 5.—O.M.B. Budget Projections (Fiscal Years).

A.

T.Q.

1977

1

1978

1979

1980

393.1

4.254 451.9

476.7

1.

Outlays

313.4

349.4

2.

Receipts

278.8

297.5

362.5

405.8

452.3

501.7

-34.7

-51.9

-30.6

-19.6

.4

25.0

1981

January 1976
(Current Programs)
1.

Outlays

324.6

373.7

98.2

391.9

420.4

441.8

465.0

489.2

2.

Receipts

281.0

297.3

87.3

374.1

430.1

491.7

551.1

623.9

-43.6

-76.4

-10.9

-17.8

9.7

49.9

86.1

134.7

3. Deficit
C.

1976

January 1975

3. Deficit

B.

1975

January 1976
(With Proposed
Changes)
1.

Outlays

324.6

373.5

98.0

394.2

429.5

455.7

482.5

509.9

2.

Receipts

281.0

297.5

81.9

351.3

406.7

465.3

523.1

585.4

-43.6

-76.0

-16.1

-43.0

-22.8

9.6

40.6

75.5

3. Deficit




TABLE 6.—C.B.O. Budget Projections (Fiscal Years).

A.

1976

T.Q.

1977

1978

1979

1980

1981

Path A
1.

Outlays

324.6

374.9

101.7

419.9

448

480

518

560

2.

Receipts

281.0

300.8

86.0

383.3

445

509

577

652

-43.6

-74.1

-15.7

-36.6

-3

29

58

92

3. Deficit
B.

1975

Path B
1.

Outlays

324.6

374.9

101.7

424.9

464

495

530

563

2.

Receipts

281.0

300.8

86.0

360.0

401

448

497

550

-43.6

-74.1

-15.7

-64.9

-63

-47

-33

-13

3. Deficit

Source:




Congressional Budget Office, Five Year Budget Projections9 p. 9.

-10accept the presumption that we will be plagued by inflation continually in excess of six percent per year through 1981.

This

leaves us with a comparison of the C.B.O. path B and the O.M.B.
projections with proposed changes.
projections through fiscal 1978.

I shall concentrate on the

The O.M.B. has faster real

growth, a faster decline in unemployment, and an initially lower
inflation rate (though by 1978 both projections are assuming 5.9
percent inflation).

The slower inflation, the lower unemployment,

and the assumption about the declining real value of government
transfers are jointly responsible for the lower dollar value of
outlays in fiscal 1977 and 1978 in the O.M.B. projections.
Of the three, I am inclined to belive the first two, and
discount the latter.

Thus if I had to make an estimate of the

dollar value of current services through fiscal 1978, I would
place it between the two estimates.

On the other hand, I think

that we have to allow for increases in government activity beyond the current services levels over this period of time,
particularly in such areas as health insurance legislation,
which would further increase the level of outlays.
If we compare the receipts projections, they are strikingly
similar for fiscal 1978, but the O.M.B. projections are lower
in fiscal 1977 and the transition quarter.

This cannot really

be attributed to differences in economic assumptions, since in
spite of the differences in the projections of the two agencies
for inflation and real income growth, their projections for the
paths of personal income and corporate profits are almost identical
(see Table 2 and Table 3 ) . It is these latter two which are
crucial for determining the yield of the Federal Tax laws.
difference in revenue projections is something of a mystery.



This

-lilt could be written off to the proposed tax law changes in the
President's budget, but since those proposals include major increases in the revenue expected to be generated by the social
security and unemployment insurance taxes (5.4 billion), it seems
hard to account for the difference of almost 9 billion dollars in
the revenue projections in fiscal 1977.
Both of these revenue projections are conditional on inflation
rates not declining signficantly, or even increasing from present
epxerience.

As we have learned from the experience of the early

1970's, tax revenue projections are extremely elastic with respect
to the assumed inflation rate.

If we look forward to a continuing

decline in the inflation rate, then both revenue projections
should probably be revised downward, and more than proportionally
to any downward revision in the outlay side of the budget.
My conclusion from all of this is that the financing problem,
even on a current services basis, will be substantial through
the end of fiscal 1978.
the C.B.O. path

Projections such as that of O.M.B. and

A which suggest a return to near budget balance

by around fiscal 1979 and the development of 'budget margins'
thereafter seem highly suspect.

My projection would be that we

can expect that somewhere in the order of 100 to 125 billion
will have to be financed in the 2 1/4 years starting July 1, 1976.
How soon therafter a 'budget margin' might develop is really impossible to forecast at the present time.

The actual size of

the budget as measured by total outlays is probably

best

estimated somewhere between the O.M.B. projections and the C.B.O.
path B, at least through fiscal 1978.




Footnotes

Most, if not all, of the information required to do the reconciliation of the financing column and the borrowing from the
public column is available in Table 3.12 of the National Income
and Product Accounts.
2
There probably exists a minor problem with this allocation.
I have taken the figures on borrowing from the Federal Reserve
from the Consolidated Condition Statement which appears in the
Federal Reserve Bulletin. It is my suspicion that this statement
values the Fed's portfolio of governments at par, rather than at
transactions prices. Since the borrowing from the public column
is obtained as a residual, any errors in evaluation of changes
in the Fed's portfolio will contaminate this column also.
To illustrate a particularly simple case, assume that the economic
assumptions are derived from a mechanical forecasting rule which
projects real growth and inflation at constant rates. A current
services budget projection (constant outlays in real terms) would
indicate nominal outlays growing at the inflation rate, and receipts growing at a rate faster than nominal income. Thus receipts
would be growing faster than outlays and the deficit (surplus)
would decline (rise) over time. On the other hand, there is no
presumption that the constant services budget is exactly what is
required to produce the constant real growth and constant inflation
rate.
see The Budget of the United States Government, January, 1976, p. 27
For example see the proposals recently offered by Rep. Brock Adams,
Chairman of the House Budget Committee, for fiscal 1977 expenditures
totalling 410.3 billion, compared with the administrations 394.2
billion. (reported in Wall Street Journal, February 19, 1976)