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RECENT MONETARY DEVELOPMENTS AND
FUTURE ECONOMIC PERFORMANCE
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
OF THE
COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
l<'IRST SESSION
SEPTEMBER
27, 1977
Printed for the use of the
O:>mmi,ttee on Banking, Finance and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
97-814 0
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Federal Reserve Bank of St. Louis
WASHINGTON : 1977
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY is. REUSS, Wisconsin. Ohairman
~ROMAS IL. ASHLEY, Ohio
J. WILLIAM STANTON, Ohio
WILLIAM S. MOORHEAD, Pennsylvania
GARRY BROWN, Michigan
J.i'ERNAND J. ST GERMAIN, Rhode Island CHALMERS P. WYLI-E, Ohio
HENRY B. GONZALEZ, Texas
JOHN H. ROUSSELOT, California
JOSEPH G. MINl•SH, New Jersey
STEWART B. McKINNEY, Connecticut
GEORGE' HANSEN, Idaho
FRANK ANNUNZIO, Illinois
HENRY J. HYDE, Illinois
JAMES M. HANLEY, New York
RICHARD KIDLLY, Florida
FARREN J, MITCHELL, Maryland
WALTER E. F'AUNTROY,
CHARLES E. GRASSLEY, Iowa
District of Columbia
MILLICENT FENWICK, New Jersey
JIM 'LE.A:CH, Iowa
STEPHEN L. NEAL, North Carolina
NEWTON I. STEER'S, JR., Maryland
JERRY M. PATTERSON, California
JAMES J. BLANCHARD, Michigan
THOMAS B. EVANS, JR., Delaware
CARROLL HUBBARD, JR., Kentucky
BRUCE F. CAPUTO, New York
HAROLD C. HOLLENBECK, New Jersey
JOHN J. LAFALCE, New York
GLADYS NOON 'SPELLMAN, Maryland
LE·S AUCOIN, Oregon
PAULE. TSONGAS, Massachusetts
BUTLER DERRICK, South Carolina
MARK W. HANNAFORD, California
DAVID W. EVANS, Indiana
CLIFFORD ALLEN, Tennessee
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
HERMAN BADILLO, New York
EDWARD W. PATTISON, New York
JOHN J. CAVANAUGH, Nebraska
MARY ROSE OAKAR, Ohio
JIM MATTOX, Texas
BRUCE F. VENTO, Minnesota
DOUG BARNARD, Georgia
WES WATKINS, Oklahoma
PAUL NELSON, Olerk an«i StaW Director
WILLIAM P. DIXON, General Oounsei
MICHAEL P. FLAHERTY, Oounsei
GRASTY CREWS II, Oounsei
MERCER L. JACKSON, Minority StaW Director
GRAHAM T. NORTHUP, Deputy Minority Staff Director
SUBOO:M:MITTEE ON Do:MESTIO MONETARY POLICY
PARR·EN J. MITCHELL, Maryland, Ohairman
STEPHEN L. NEA·L, North Carolina
GEORGE HANSEN, Idaho
NORMAN E. D'AMOURS, New Hampshire
HAROLD C. HOLLENBECK, New Jersey
DOUG BARNARD, Georgia
BRUCE F. CAPUTO, New York
WE'S WATKINS, Oklahoma
BUTLER DERRICK, South Carolina
MARK W. HANNAFORD, California
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Federal Reserve Bank of St. Louis
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CONTENTS
STATEMENTS
Dewald, William G., professor of economics, Ohio State University, and
editor of "Journal of Money, Credit and Banking"____________________
Gibson, Dr. William, vice president and manager, fixed income research
department, .Smith, Barney, Harris, Upham & Co., Inc________________
Laidler, Prof. David, Department of Economics, the University of Western Ontario, London, Canada_______________________________________
Partee, Hon. J. Charles, member, Board of Governors of the Federal
Reserve System____________________________________________________
'.Page
57
52
68
5
.ADDITIONAL INFORMATION SUBMITTED FOR THE RECORD
"Briefing Papers for Monetary Policy Oversight Hearings" with attached
exhibits prepared by the subcommittee staff________________________
Burns, Hon. Arthur F., Chairman, Board of Governors, Federal Reserve
System:
Letter dated September 22, 1977, expressing reservations about "Board
testimony on the conduct of our Nation's monetary policy" being
presented at other than quarterly hearings before House and Senate
Banking Committees pursuant to H. Con. Res. 133________________
Statement presented before the House Committee on Banking, Finance
and Urban Affairs, July 29, 1977-_______________________________
Dewald, Prof. William G., article entitled "The Trend of Business" on
economic forecasts for 1978, from the Bulletin of Business Research,
dated August 1977_________________________________________________
1\Iitchell, Chairman Parren J., article entitled "'Vhy Inflation Persists,"
by Milton ]jlriedman from Newsweek magazine of October 8, 1977____
Watkins, Hon. Wes, article entitled "The Money Mess" by Lindley H.
Clark, Jr., from the Wall ,Street Journal of September 27, 1977 ________
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8
9
58
76
45
RECENT MONETARY DEVELOPMENTS AND FUTURE
ECONOMIC PERFOR1IANCE
TUESDAY, SEPTEMBER 27, 1977
HousE OF REPRESENTATIVES,
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY O}' THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.0.
The subcommittee met, pursuant to notice, at 8 :37 a.m. in room
2220, Rayburn House Office Building, Hon. Parren J. Mitchell ( chairman of the subcommittee), presiding.
Present: Representatives Mitchell, Barnard, Watkins, Derrick,
Hannaford, Hansen, and Caputo.
Chairman MITCHELL. The hearing will come to order.
Today's hearings have been called to discuss recent monetary developments. Since early spring, short-term interest rates have increased
100 to 150 basis points, and the conventionally defined money supply,
M 1, has grown at an annual rate of 9.1 percent, which is 40 percent
above the Federal Reserve's current target range of 4 to 6½ percent
annual M1 growth.
Many economists stress interest rates in their analysis of the impact
of monetary policy on the economy. Others stress money supply. Recent developments are disquieting to both camps.
Those who stress interest rates warn that the goals of the Carter
administration for 1980-full employment and a balanced budgetcannot be achieved if interest rates are allowed to rise. The Joint
Economic Committee, in its "1977 Midyear Review of the Economy"
cites a study by Prof. Ray C. Fair of Yale University who told the
committee that:
"If the Fed behaves by keeping the bill rate unchanged, full employment and a balanced budget are reached by 1980."
But, Professor Fair argues, if the bill rate is allowed to rise, the expansion is aborted and the goals are not met. The Joint Economic
Committee states that "Professor Fair's results imply that the maintenance of a constant bill rate will require M1 to grow at a rate between 10 and 11 percent in 1978 and 1979." Under this view of the
economy then, 9 percent annual money growth is not enough.
However, economists who stress money supply in their analyses point
out that M1 growth in the 9-percent range, if long sustained, will
trigger another calamity boom. This would delay recession for a time,
perhaps even until 1980, although quarter to quarter dhanges are likely
to be bumpy. But in their views, money growth as high as 9 percent per
year will cause accelerating inflation, beginning as early as mid-1978.
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In turn, the added inflation will lay the foundation for a deep recession later on; and the longer it is delayed by accelerating money
growth, the worse it will be.
As I understand it, monetarists are not sanguine about the future
even if M1 growth is now squeezed back to the 4 to 6½ percent track.
They point out that if money growth is not quickly decelerated to
bring it within the Federal Reserve's 4 to 6½ percent target range for
1977 as a whole, the recovery is almost certain to be set back later this
year. On the other hand, the longer the delay in moderating the money
growth, the greater the risk of triggering another calamity boom.
Thus, the speedup in money growth during the past 6 months may
have created a dilemma, neither horn of which is pleasant to grab;
a choice between slowing, even aborting the recovery now, or accelerating inflation and courting a deeper recession later on.
I have called these hearings to find out what is happening in monetary policy, what it means, and what remedial steps are necessary, if
a·ny. Specifically, we need answers to the following questions:
One, why are short-term interest rates rising at the same time that
money growth is accelerating 1
Two, would still faster money growth contain upward pressures on
interest rates 1
Three, what are the risks of 9 percent or even faster money growth,
for example 10 or 11 percent per year 1
Four, would the recovery abort if M1 growth was squeezed so as to
be under 6½ percent for 1977 as a whole 1
Five, might not the best solution now be to start anew; to design a
money growth track from this day forward, consistent with achieving
full employment, stable prices and moderate interest rates 1
Six, wha.t track would you design i
Our first witness will be Gov. J. Charles Partee, member of the
Federal Reserve Board-I am delighted to see you again, sir. After
he has testified and the members have had a chance to question him,
we will have a panel of three eminent economists: William G. Dewald,
professor of economics, Ohio State University, and editor of the
"Journal of Money, Credit and Banking"; Dr. "'\Villiam Gibson, vice
president and manager of the fixed income research department of
Smith, Barney, Harris, Upham & Co., Inc.; and Prof. David Laidler,
a renowned English monetary expert now with the University of
estern Ontario, London, Ontario, Canada.
Before proceeding, I want to state that Chairman Arthur F. Burns
of the Federal Reserve Board has expressed reservations about
"Board testimony on the conduct of our Nation's monetary policy"
being presented at ether than the quarterly hearings, which are held
alternately before the House and Senate Banking Committees pursuant to House Concurrent Resolution 133.
His position was set forth in a letter which he sent .to me dated
September 22 and received last Friday, September 23. Subcommittee
members have been provided copies of the letter.
In his letter, Chairman Burns asked that the subcommittee consider his position and deal with the question of policy that he raises.
Essentially, the questi_on is whether it _is constructive f~r this s~bco!Ilmittee, the Subcommittee on Domestic Monetary Pohcy, to mqmre
,v
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into monetary developments in public session with officials of the
Government agency responsible for monetary policy.
I think it is a fair question that has been raised. I would ask the
subcommittee members to study Dr. Burns' correspondence.
[The letter received from Chairman Arthur F. Burns follows:]
CHAIRMAN OF THE BOARD OF GOVERNO_RS
FEDERAL RESERVE SYSTEM
WASHINGTON, 0, C. 20551
September 22, 1977
The Honorable Farren J. Mitchell
Chairman
Subcommittee on Domestic Monetary Policy
Committee on Banking, Finance and
Urban Affairs
House of Representatives
Washington, D. C.
Dear Mr. Chairman:
Thank you for your letter of September 14 asking the
Board to testify on "Recent Monetary Developments and Future
Economic Performance" on September 27.
As you know, pursuant to H. Con. Res. 133, the Chairman
appears before the Banking Committees of the Congress four ftmes
a year to testify on monetary policy developments. I so testified
before the Senate Banking Committee on May 3 of this year and
before the House Banking Committee on February 3 and July 29.
I am scheduled to testify before the Senate Banking Committee
in early November. I welcome these appearances before the
Congress and have publicly indicated on various occasions that
they have served our nation well.
However, I doubt that a constructive purpose would be
served by Board testimony on the conduct of our nation's
monetary policy at more frequent intervals. Given the customary
pace of change in economic and financial conditions, more frequent
hearings are likely to be repetitive or to place undue stress on
transitory developments. Not only that, but the significance that
now attaches to the statutory quarterly hearings would be diluted.
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The Honorable Farren J. Mitchell - Page 2.
I welcomed the initiative you took earlier this year to
arrange an informal meeting with the members of your Subcommittee. As I indicated to you last Friday, I would be happy
to meet informally with you and members of your Committee
at any time and I thought that you were agreeable to this suggestion.
I think it would be desirable for your Subcommittee to
consider my position, and I trust you will deal with the question
of policy that I raise. I realize that you may be unable to do this
immediately, and I therefore want to assure you that a member
of the Board will appear before your Committee on September 27,
as you originally suggested.
With kind regards,
Sincerely yours,
Arthur F. Burns
Chairman MITCHELL. I will probably have a brief meeting with you
to get your reactions to this problem area, but certainly, we will not
do that this morning.
Our immediate concern is to hear from Governor Partee, what he
has to say about recent monetary developments and then what the
other witnesses have to say. Governor Partee, I am delighted that
you are here. The public needs to know what is going on. We are looking fot"ward to receiving your testimony and to questioning you about
recent monetary developments and their bearing on our future economic performance.
Before asking you to testify, I will turn to our ranking minority
member to see whether he has an opening statement.
Mr. CAPUTO. I have not.
Chairman MITCHELL. Mr. Hannaford has a statement he would like
to make, as of this time.
Mr. HANNAFORD. Thank you, Mr. Chairman. I would like to commend you for calling these hearings although Chairman Burns appears to take issue with the subcommittee's desire to discuss recent
monetary policy developments.
The purpose of the hearing is to raise particular questions regarding the recent growth of the money supply. High growth rate of M1
outside of the Fed's established target range is a matter which deserves
the full attention of this subcommittee.
We all know the Fed's conduct in monetary policy affects the lives
of everyone in this country, fundamentally.
We, in the Congress, are working hard to combat inflation, and
unemployment, and we need to work with the Fed and not against
it. I am confident that there is no desire to politicize the central bank.
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What I am stressing is that the Federal Reserve, as an agency of
the Government, must realize that Congress and its oversight committees are interested in its operations and that we share the responsibility for increasing public awareness of the institution's functions and the role it plays in our economic affairs.
To this end, a few weeks ago H.R. 8094, the Federal Reserve Reform Act, was passed by the House. The bill attempts to increase
the accountability of the Federal Reserve System to the public and
to the Congress.
That bill is, indeed, a modest one. As my colleagues are aware, I am
interested in having the Federal Open Market Committee reinstate
detailed minutes of its meetings.
This practice was discontinued in May 1976. As this provision
is not included in H.R. 8094, Mr. Chairman, it is my intention to
introduce a bill to that effect.
I would like to call this to the attention of my colleagues on the
subcommittee and invite their cosponsorship of that legislation, as
I introduce it.
Thank you.
Chairman MITCHELL. The Chair would like to ask a question. When
do you anticipate introducing your bill i
Mr. HANNAFORD. I have a copy of the legislation prepared.
I would anticipate putting it in today, unless you would like to
see it, Mr. Chairman.
Chairman MITCHELL. No. I just was trying to calculate whether or
not we would have time before the recess to hold hearings in this
subcommittee on that bill. I see no reason why we shoulq not.
Mr. HANNAFORD. I will put it in today.
Mr. MITCHELL. Thank you very much.
Governor, again welcome. We are anxious to hear your testimony.
STATEMENT OF HON. ;r, CHARLES PARTEE, MEMBER, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Governor PARTEE. Thank you, Mr. Chairman.
I have a short statement after which I will be glad to try to answer
the subcommittee's questions.
I am pleased to appear before this committee today to present the
views of the Federal Reserve Board with respect to recent monetary
developments. As I understand it, the purpose of this hearing is to
provide an updating of the recent monetary oversight hearings of
your parent committee, at which Chairman Burns appeared. My remarks therefore will supplement his, and I think it would be appropriate to include a copy of the Chairman's testimony on that occasion
as an attachment to my much briefer statement.
As Chairman Burns indicated at the July 29 hearings, the FOMC
at its July meeting adopted new longer-run growth ranges for the
monetary aggregates that it expected to be appropriate to the needs
of the economy over the coming year. These growth rate ranges were
4 to 6½ percent for M1-defined to include currency and demand deposits at banks-7 to 9½ percent for M 2-which is M1 plus savings
and time deposits-except for large negotiable CD's-at the banks-
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and 8½ to 11 percent _£or Ma-which is M 2 p~us ~eeo~its at the th~ift
institutions. The Chairman also noted that 1mphc1t m these proJections for monetary growth was the expectation that the velocity_ of
M1 would continue to increase at a faster rate than it had durmg
comparable periods of previous business cycle expansions, and that,
because of heightened uncertainty as to the relationship between rates
of monetary expansion and the performance of the economy, the Federal Reserve would continue to maintain a posture of vigilance and
flexibility in the period ahead.
The fact is that the pace of monetary expansion now appears to
have been unusually rapid during recent months. This is especially
true of the narrowly defined money supply, where the increase over
the past 6 months-from February to August-is indicated to have
been at an annual rate of 9.1 percent. This rate of expansion, of course,
is well above the FOMC's stated longer-run range of projections.
Broader measures of the money supply, on the other hand, have grown
at rates only a little above the upper end of the committee's projected
ranges. During the past 6 months, M 2 and Ma have increased at annual
rates of 9.9 percent and 11.3 percent, respectively. I might note that
over longer time periods-the past year, for example-growth in M1
has been more moderate while the increases in M 2 and M 3 have been
somewhat higher than those I have just cited. And over all of the
period of economic recovery, dating from the first quarter of 1975,
the expansion in the narrow money supply has averaged just over 6
percent per annum.
As the recent expansion in the monetary aggregates tended to run
a.hove the FOMC's expectations, System operations have been directed
toward holding down on the provision of bank reserves needed to
support the larger monetary totals. Just as in any other market, the
more limited availability of reserve supplies relative to demands has
meant that prices-in this case, interest rates-have gone up on dayto-day bank borrowings-Federal funds-and other very short-term
sources of financing. The rate paid on Federal funds, for example, is
up about 1½ percentage points from the lows prevailing early this
year, with almost all of the rise taking place during and after the
April and July runups in the narrow money supply. Other short-term
market interest rates also have been affected, but longer-term interest
rates, which are of much greater significance to the economy, have
not increased on balance despite the firming since April in short-term
market conditions.
Some would argue that the Federal Reserve should have responded
more forcefully to the April and July bulges in the money supply.
Indeed, a few would say that the reserves necessary to support the
deposit expansion simply should not have been provided, letting financial markets and the economy suffer whatever consequences might
result. But the FOMC continues to believe that the wiser course is to
limit .the speed with which money market conditions are adjusted to
changing monetary growth_ rates. We believe this partly because the
monetary aggregates-particularly M 1-have proved to be inherently
unstable in the short run. Bulges of a month or two in duration are
often reversed subsequently, as was the case in the spring and summer
of 1975 and again in 1976. Prudence in our actions is dictated also by
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the :fact that the relationship between the various measures o:f monetary growth and the performance o:f the economy is loose and unreliable, since it is subject to rather abrupt shifts as the result of changing financial practices and economic conditions.
In the current situation, :for example, there are a number of ambiguities for which we do not yet have the answers. Until there is
more information, it seems to me that one should be very cautious
about prescribing a policy o:f stern monetary restraint.
First, the excessive growth in the narrow money supply this year
has been concentrated in just two 1-month periods-April and July.
We do not have a good explanation for these bulges. It may be that
they reflect in part a shift in the seasonal pattern of money demand.
If so, it is entirely possible that a period of adjustment in money
growth could lie ahead, just as it has in the latter part of other recent
years.
Second, the abnormal expansion that has occurred over the past 6
months has been concentrated in the narrow money supply, while the
growth in broader monetary measures-though substantial-has been
much closer to our expectations. One reason :for this development may
be that the accelerated pace at which other forms of deposit and liquid
asset instruments were being substituted for bank checking account
balances has now slowed, at least temporarily. That would modify
the meaning of the changed relative growth rates of the various monetary aggregates, in terms of probable impact on future economic performance, since it would simply reflect a shi:ft in holder preference
:from one form of deposit to another.
Third, the behavior of the economy this spring and summer, though
generally satisfactory, does not suggest that a major new boom is in
process of developing. Indeed, both the growth in real activity and the
pace of inflation have slowed somewhat in recent months, following
acceleration earlier in the year. This has been true also abroad, where
most developed countries to date have shown only rather sluggish
recoveries. Nor has there been a rush of business borrowing at the
banks, though credit demands in general have been well sustained.
Thus the current economic data do not suggest that businesses and
households are building up cash balances with a view to increasing
abruptly their rate 0£ expenditure. Since sizable unused resources
still exist in this and other economies, moreover, there is no immediate
need to restrain excessive expansion, and there should be time to check
any speculative surge in spending and investment that might develop.
I can assure you that the Federal Reserve has been concerned about
the recently accelerated growth in the narrow money supply, and that
we are monitoring this development closely. And I want to emphasize
that we have by no means given up on our views as to the ranges o:f
growth :for the family o:f monetary aggregates that are appropriate
in the longer run to the needs of the economy. The recent tendency
toward excess has proceeded in fits and starts, however, and we cannot
yet ho sure how durable-or meaningful-these increases are likely
to be. Our efforts to restrain the monetary expansion must therefore
be judicious. With the unemployment rate nationally still hovering
around 7 percent, we would not warit to contribute to conditions in
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credit markets that might imperil the prospects for sustained economic recovery.
Thank you, Mr. Chairman.
[The statement of Chairman Arthur F. Burns before the House
Committee on Banking, Finance ·and Urban Affairs on July 29, 1977,
referred to by Governor Partee in his opening remarks, follows:]
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Statement by
Arthur F. Burns
Chairman, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Finance, and Urban Affairs
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I am. pleased to appear before this Committee once
again to present the report of the Federal Reserve Board on
the condition of the national economy and the course of monetary
policy.
Since the closing months of 1976, our Nation has experienced a vigorous and broadly based economic expansion.
The
gains in the industrial sector have been especially impressive;
during the past 8 months, the combined output of factories, mines,
and power plants has risen at an annual rate of 9-1 /Z per cent.
Activity in other sectors of the economy also has. increased
briskly. As a result, total employment in June was almost 3
million higher than last October -- an unprecedented gain in so
short a period.
The unemployment rate rem.ains high; but it has
declined in recent months by nearly a full percentage point,
despite rapid growth of the labor force.
The rate of utilization
of our industrial plant capacity also has risen significantly, and
now exceeds 83 per cent in manufacturing.
Demand for consumer goods has continued to propel the
expansion.- With confidence buoyed by improving economic
conditions, consumers have been spending freely from current
income besides adding significantly to their personal indebtedness.
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The strong buying mood of consumers is reflected in the
personal saving rate, which in the first half of this year
averaged less than at any time since the early 1960 1 s.
Retail sales climbed steeply during the fall and
winter mo~hs and· remained at a high level thi• spring.
Over the past three quarters, retail sales, after adjustment
for price increases, have risen at an annual rate of about
6 per cent. Auto sales contributed greatly to the advance,
averaging -- on a seasonally .adjusted basis -- almost one
million cars per month since March.
The rise of consumer spending playecl a major role in
prompting a resurgence of inventory investment early this year.
A moderate inventory correction in the latter part of 1976 had
reduced the ratio of stocks to sales to exceptionally low levels
in many lines of trade and manufacturing.
Once sales again
accelerated, businessmen had to rebuild their inventories in
order to meet customer demands.
The annual rate of additions
to business inventories reached $14 billion in the first quarter
of this year, and perhaps $ZO billion in the quarter just ended.
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In the past two months or so, it appears that stocks
in certain categories of nondurable goods reached somewhat
higher levels than businessmen desired.
The la.test data on
employment and production in manufacturing suggest that
business firms have again moved promptly to reverse the
build-up.
With inventory positions generally still lean and
sales prospects favorable, inventory investment is likely to
contribute to economic expansion later in the year and on into
1978.
The upward trend of sales and of capacity utilization
has encouraged businessmen to enlarge their outlays for
plant and equipment.
There are some signs that business
capital spending may finally be gaining significant upward
momentum,
Order backlogs of capital goods manufacturers
have been climbing.
Business equipment posted the largest
advance of any major category of industrial production during
the first half.
New contracts and orders for plant and equipment
most recently have been running more than 20_per cent above
year-earlier levels.
To date, business capital expenditures
have been concentrated largely on vehicles and other light
equipment, but there is some tentative evidence that large
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construction projects and heavy machinery are beginning to
make a contribution to the capital-goods recovery.
All told,
the evidence at hand points to moderate strength in spending
on plant and equipment in the months ahead.
Residential construction meanwhile has remained a
major area of strength in the economy.
Home sales have
been brisk, and the average level of single-family housing
starts in the second quarter was the highest in more than
two decades.
The multi-family sector has continued to
recover slowly, but the low vacancy rates in many localities
are likely to stimulate additional construction. In certain parts
of the country, especially in California, speculative activity
in the single-family sector has recently emerged and this
development bears watching.
In general, however, the
expansion of homebuilding seems to be realistically attuned
to the Nation's mobile population. In the Board's judgment,
residential construction will post further gains in coming quarters.
Governmental spending has picked up recently, most
markedly in the State and local sector.
The budgetary position
of many State and local governments has imprcw.ed considerably,
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being bolstered by Federal grants, by higher tax rates, and
by the effects of economic expansion on tax revenues. State
and local units ha.ve been able to expand employment more
rapidly of late, although growth has not been as strong as in
the 1960's and early 1970's.
Their construction programs,
delayed in many cases as governmental units concentrated on
rebuilding their financial position, are moving ahead again and
should provide significant impetus to economic activity in coming
quarters.
The only major weak spot in the economy has been the
foreign trade sector.
Exports have been sluggish this year,
being limited by the relatively slow economic expansion in
other industrial nations.
Most of these countries have expe-
rienced indecisive rebounds in business investment, and this
has restricted the demand for American machinery -- an
important part of our sales abroad.
Cyclical developments have also played a large role
on the import side of the trade ledger.
In general, the. demand
for imported industrial materials has increased in step with the
recent rapid growth of production in this country. Imports of
cyclically-sensitive durable goods -- S\.l.ch as machinery, autos,
and other consumer items -- are also reflecting recent economic
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trends.
And needless to say, oil imports have risen enormously
this year, swelled first by cold weather and then by inventory
building in anticipation of OPEC price increases.
Continuing advances in investment income and other
nontrade items have partly offset the deficit in our foreign trade;
even so, the current-account deficit has reached record size.
Oil imports should experience some decline later this year,
aided by the availability of Alaskan oil,
But prevailing trends
in economic activity here and abroad suggest little likelihood
of significant near-term reduction in our foreign trade or
current-account deficits,
In general, financial developments have favored economic expansion in our country, and they are continuing to do so.
However, some familiar cyclical patterns have begun to emerge
since the turn of the year.
Borrowing by households has been growing very rapidly,
Instalment credit has expanded at a 16 per cent annual rate thus
far this year.
Measured relative to disposable personal income,
growth of instalment credit has reached a pace comparable to
past peak rates.
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Mortgage credit flows have been of record magnitude.
Mortgage credit has in fact grown much faster than could bi!
expected on the basis of past relationships between borrowing
and residential construction, thus suggesting .that households
have been putting mortgage funds to a broad variety of uses.
Despite the rapid growth of consumer
~
mortgage
credit, measures of household debt burden generally remain
within the range of historical experience.
Moreov,er, delin-
quency and bankruptcy rates have declined significantly from
their recession highs.
At this juncture, debt burdens do not
apeear to constitute a serious impediment to further gains in
household expenditures; but we must not overlook the possibility
of excesses in this area.
Business firms also have placed heavy demands on
credit markets this year.
Their over-all need for external
financing has grown because capital outlays have risen much
faster than profits.
The net funds r•aised by nonfinancial
corporations increased by about 30 per cent between the
second half of 1976 and the first half of this year.
The character of business borrowing has also shifted
considerably.
Until the latter part of 1976, business firms
concentrated on repayment of short-term debt with the proceeds
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of long-term borrowing. Since last fall, long-term indebtedness
has continued to grow, but not nearly so rapidly as short- and
intermediate-term borrowing.
Bank loans to businesses have
increased at an annual rate of 11 per cent since last September,
and comm.ercial paper and finance company loans have increased
even faster.
These developments have caused liquidity ratios
of corporate balance sheets to decline somewhat -- a normal
cyclical development, although delayed in this case. Still, the
state of corporate liquidity remains relatively comfortable
because of the extensive improvement achieved during the preceding two years.
Credit demands by State and local governmental units
have been very large this year.
About a fifth of the reaord
bond offerings has been devoted to advance refunding of debt
issues that were sold in earlier years when interest rates
were appreciably higher.
The remainder has included sub-
stantial amounts to finance construction of public power plants,
hospitals, and water and sewer facilities.
Federal Government borrowing, in contrast, has
declined from last year -- a development which, among other
things, reflects the recovery of Treasury revenues and an
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expenditure pattern still characterized by shortfalls.
However,
both the Acbninisf:ration's projection and the First Concurrent
Resolution indicate that the deficit for fiscal year 197 8 will
substantially exceed that in the current year.
If actually
realized, this would be an unusual development.
Normally,
of course, Federal borrowing diminishes in the course of an
economic expansion.
In view of the probable need to finance
an increasing volume of private capital formation, the prospect
of greater demands for funds by the Federal Government in the
next fiscal year has been a cause of some disquietude in financial
circles.
The strong demands for money and credit: that: have
accompanied our economic expansion have been reflected in
a rise of short-term .interest rates since the turn of the year,
The Federal Reserve might: have accommodated credit: demands
by providing bank reserves more liberally.
However, such a
course would only have postponed briefly the rise in interest
rates because the resulting build-up of liquidity would have
intensified inflationary expectations,
By responding promptly
to the enormous expansion of the monetary aggregates in April,
the Federal Reserve gave clear notice that it was alert: to the
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19
danger of a new wave of inflation.
This reassurance to the
business an4 financial community that the Federal Reserve
would not permit the money supply to run riot was well
received by credit markets.
Long-term interest rates, of
course, are of much larger significance to the economy than
short-term rates; but the long-term rates are also especially
sensitive to inflationary expectations.
It is well, therefore,
to take note of the fact that interest rates on co_rporate and
municipal bonds, instead of following the recent rise in shortterm rates, remained fairly stable and are actually a little
lower now than they were in April.
These developments in credit markets are, I believe,
attributable in significant part to public confidence in the Federal
Reserve's monetary policy.
It is noteworthy that, in general,
interest rates still remain below levels prevailing at the
beginning of the economic recovery.
During the past half year, the Federal Reserve bas
managed to keep the growth of the major monetary aggregates
on a moderate path.
M 1 -- which consists of currency and
checking accounts at commercial banks -- increased at an
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annual rate of 6. 4 per cent. This is a faster rate of growth
than occurred last year, and it reflects the very intense
deniand for transactions .balances in recent months.
Growth
of the broader aggregates, on the other band, baa been slower
than last year -- a deceleration due partly to the low personal
saving· 1'ate that has evolved and partly to some modest re-
direction of savings flows away from deposit accounts to
market securities as abort-term interest rates have risen.
Despite the nioderate slowing of the broader monetary aggregates,
financial institutions -- both com:mercial banks and the thrift
institutions -- remain relatively liquid and in a good position
to continue supporting economic expansion.
During the next few quarters, it. is improbable that
over-all economic growth will proceed as rapidly as it did
during the past six months.
Typically, bursts of consumer
spendi:ng of the kind witnessed this year are followed by phases
of moderation.
Such moderation, indeed, seems to be signaled
by recent data on retail sales.
Nor, of course, is it to be
expected that inventory investment will be adding as much to
economic expansion as it did in preceding quarters.
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And in
21
view of the high rate of single-family housing. starts already
attained, it is likely that housing will contribute less to growth.
These probable developments, however, do not portend
an end to general economic expansion. We at the Boa.rd anticipate
continuing growth -- albeit at less rapid rate■ -- in consumption,
inventory investment, and homebuilding.
We tbink, moreover,
that investment activity by business firm• will maintain a good
growth pace and perhaps accelerate as
busine■ amen
are con-
fronted, as they may well be, by reduced capacity margins
next year.
Meanwhile, as I noted earlier, there is reason to
expect that the pace of State and local government spending will
continue to quicken. What these various trends suggest is a
change in the character of the expansion - - with the over-all
growth rate slowing but still high enough to produce some further
reductions in unemployment.
The fact that the Nation's unemployment rate remains
high by historical standards is a source of continuing concern.
If we as a people are to address this problem effectively, our
first task is to understand the special factors that make it so
difficult now to achieve rapid reductions in joblessness.
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The stickiness of the uneJnployment rate, it needs to be
am,reciated, does not reflect unusual slowness in the opening up
of new job opportunities during the current expansion.
On the
contrary, the growth of jobs since the recession trough in
March 1975 -- some 6-1/2 million -- has been more rapid than
during the comparable phase of any cyclical recovery since
World War II.
It happens, however, that the rate of increase
in the labor force also has been unprecedentedly rapid in the course
of this expansion -- amounting to more than 5-1/2 million persons.
Consequently, despite the huge rise that has occurred in em.ployment, the reduction in over-all unemployment has been modest.
The single most important reason for the fast pace of
labor force growth has been a veritable rush of adult women
into the job market.
Indeed, of the increase of 5. 6 million that
has occurred in the labor force since the recession trough, 2. 4
million -- or more than 40 per cent -- is accounted for by women
of age 25 or over. Strikingly, if the percentage of this adult
female population in the labor force had been the same in June
1977 as it was in March 1975, when economic recovery started,
the adult female labor fore e would have been lower by 1-1 /2
million this June.
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Federal Reserve Bank of St. Louis
What we are witnessing, literally, is a
23
revolution in the role of women in our society, and we need
to focus on the economic implications of this phenomenon more
carefully than we have.
Obviously, the fact that the labor market has had to
absorb the "extra" influx of female job seekers is a major
reason why the Nation's over-all unemployment rate has
not moved downward more decisively.
The. rapid influx of
women into the labor force takes on particular significance
because it happens to reinforce another demogr&phic factor
that also is taxing the absorptive capabilities of the labor
market.
I refer to the continuing large additions of young
people to the labor force - - a reflection of the high birth
rates of the 19501 s.
Both adult women and young people tend to experience
unemployment rates above average.
regular job before,
Many have never held a
Others left the work force years earlier
on account of marriage or the arrival of children,
Whatever
the state of the labor niarket, a decision to enter or reenter
the labor force often involves a fairly extended period of job
hunting -- frequently prolonged by lack of knowledge about
available job opportunities,
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For niarried women -- especially
24
those with young children -- the desired job is often parttime and close to home, so that finding the right position may
take quite a lot of time.
For young people, early work experience
frequently involves various job shifts -- and sometimes several
periods of unemployment -- until a job considered appropriate
is found.
Because of the decline in birth rates which started in
the early 1960's, growth in the younger-age component of the
labor force can be expected to taper ofi in the next few years.
But no sign of tapering is as yet visible in the labor-force
participation by adult women.
A decided slowing of the inflation
rate -- if that were to occur -- might check the rise in female
labor-force participation, since some women clearly have taken
jobs in order to offset the effects of inflation on household budgets.
However, social trends seem to be of greater significance in
conditioning the movement of women into the labor force.
Attitudes toward child-bearing and child-rearing and toward
educational and career aspirations of women have been undergoing dramatic changes in our society, and it cannot be foretold
when this process will wane.
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Thus rapid labor force growth may persist, thereby
continuing to make it difficult to reduce the over-all unemployment rate to levels that were once considered reasonably con-
sistent with the goal of full employment. Indeed, the changed
age-sex composition of the labor force -- now weighted more
than formerly toward groups that tend to have higher than
average unemployment rates -- probably has imparted an
upward tilt to over-all unemploym·ent of about one percentage
point compared with ZO years ago.
In time, of course, as women gain experience in the
labor market and as businesses adapt their operations so as
to employ women more effectively, the upward bias should
lessen.
One of our prime policy objectives certainly should
be to facilitate the assimilation of adult women and young people
into the active work force.
That is not likely to be accomplished
by actions that rely simply on boosting aggregate monetary
demand.
Such actions would tend to accentuate inflationary
pressures in the economy without doing a great deal to facilitate
the desired assimilation.
In fact, the need to protect family
incomes against the ravages of inflation may cause even more
women and young people to enter the labor force.
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Federal Reserve Bank of St. Louis
We therefore
26
need to recognize very clearly that accommodation of significant
changes in the labor market requires policiee that are specifically
tailored to the elimination of structural hindrances to full
employment.
Even before the sharp acceleration of growth in the
entry of women into the labor force, there was reason to be
concerned that reasonably full use of our comm,ercial and
industrial capacity might be reached before we began approaching
full employment of our labor force.
That concern, arising from
the laggard behavior of capital formation, is now greater because
of the unexpected rapidity with which the labor force is expanding.
The inference seems inescapable that we need governmental
policies that offer decisive encouragement to capital formation.
Unless recognition of that need conditions the evolution of policies
in such major areas as energy. taxes, social security, welfare.
and govermnental regulation, there will be small hope of maximizing job opportunities in the next several years,
We need an environment that is decidedly more conducive
to business risk-taking than that which has prevailed in recent
years.
In my judgment, we are very much in danger of forgetting
that ours is basically an enterprise economy whose vitality depends
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on whether business firms are able to earn an adequate rate
of return on invested capital.
Despite the increasing role of
government in economic activities, profits are still the essential
driving force of our economic system.
Economic discussions
nowadays deal extensively with the effects of monetary and
fiscal policies on economic activity; but they do not focus
frequently enough on the even more important matter of
whether private businesses -- which dominate job creation
in our system - - have adequate incentive to expand their
operations or to undertake new ventures.
Our citizenry may
pay dearly if this myopia persists.
It also is important to rethink some of our national
policies with respect to the market for jobs. One of the most
critical needs is to avoid governmental actions which compound
the problems that newcomers to the job market already have.
New entrants -- whether young people or adult women -- often
cannot be highly productive in the initial phase of their employment.
Minimum-wage legislation is blind to that fact, and thus
limits employment opportunities for job seekers with little or
no recent work experience, With young people and other newcomers to the labor force now accounting for a disproportionate
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for
share of the unemployed, this is hardly an opportune time
Congress to contemplate a boost in the minimum wage ·that
goes well beyond the President's original recommendation.
Statutory changes in minimum wages affect not only
the lower end of the wage spectrum.
In practice, they tend
to have a leveraging effect on the general wage structure as
various tiers of workers seek to maintain the differential
between their wage and that of lower paid workers. Such a
development would reinforce the upward pressure on wages
that already derives from the continuing advanc~ of consumer
prices, from tight labor markets here and there, and from
large and well-publicized collective bargaining settlements in
some industries.
Labor costs per unit of output in the private business
sector rose by 5. 4 per cent in the year ending in March.
This
increase reflects the difference between an average increase
in labor compensation per hour of about 8 per cent and an
average increase of 2-1/2 per cent in output per manhour.
Since we are now in a phase of the business cycle when productivity gains are more likely to slow than to accelerate, the
upward pressures on wages may lead to still stronger pressures
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on unit labor costs.
Many businesses -- not always justifiably --
already feel a need to recoup labor-cost increases or to increase
profit margins.
To the extent that they succeed in raising their
selling prices, the inflation rate will tend to worsen and so too
will inflationary expectations.
To the extent they fail, profits
margins may narrow -- a development that would diminish the
likelihood of sustained expansion of capital investment.
The need to concern ourselves with impending cost
distortions and inflationary trends is evident from the price
record of the first half of this year.
That record, to be sure,
was influenced by some transitory forces, and there has been
some diminution in the rate of inflation lately.
Even so, the
rate of inflation this year is running higher than it did last year.
This is a disturbing development for international as well as
for domestic reasons.
In recent weeks, the dollar -- which had maintained
remarkable stability against the average of foreign currencies
since early last year -- has experienced limited but conspicuous
depreciation.
This is a matter that no one in our government
can or does take lightly: first, because any material depreciation
of the dollar against foreign currencies would have some adverse
effect on our domestic price level; second, because the dollar
97-814 0 - 77 - 3
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is a store of value for much of the rest of the world.
The fact
that the dollar has weakened even in relation to the currencies
of countries experiencing much gr'!later inflation than the United
States is a reminder that market psychology has a way of magnifying or distorting for a time underlying trends. A sound dollar
is essential to our economic future and everyone with major
financial responsibility in our government is keenly aware of that.
We at the Federal Reserve have persistently sought to
protect the integrity of the dollar and at the sam.e time foster
further economic expansion.
The members of the Federal
Open Market Committee, when they met earlier this month to
discuss the longer-run growth of the monetary aggregates,
carefully considered international as well as domestic developments.
The Committee decided to leave unchanged for the year
ending in the second quarter of 1978 the previously projected
growth ranges of the broader monetary aggregates.
Mz
thus
is projected to grow within a range from 7 to 9-1/Z per cent
during the next year, and M3 within a range from 8-1/Z to 11
per cent. An adjustment, however, was made in the growth
range for M1; the lower boundary of this range was dropped by
one-half of a percentage point, so that this aggregate is projected
to increase within a range from 4 to 6-1/Z per cent in the year ahead.
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The adjustment in the projected growth raiige for M1.
while amall, represents another step toward bringing the longrun growth of the monetary aggregates down to rates compatible
with general price stability. Sustained progress in this
direction is essential if the Administration's publicly announced
goal of reducing the pace of inflation by about two percentage
point• by the end of 1979 is to be achieved.
The trend of growth in monetary aggregates, I regret
to say, is still too rapid.
Even though the Federal Reserve
has steadily sought during the past two years to achieve lower
ranges for monetary expansion, the evolution of its projections
has been extremely gradual; indeed, at the pace- we have been
moving it would require perhaps a decade to reach rates of
growth consistent with price stability.
I must report, more-
over, that despite the gradual reduction of projected growth
ranges for the aggregates during the past two years, no meaningful reduction has as yet occurred in actual.growth rates,
That unintended consequence is partly the result of data
deficiencies that complicate the already formidable task of
adjusting or approximating monetary growth objectives.
Some of the data deficiencies we have experienced are being
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overcome.
Even so, monetary measurement will continue to
lack the precision of a science. So too will the Federal lteserve's
actions aiming to influence developments in financial markets.
Implicit in our projections for monetary growth is the
expectation that the velocity -- or turnover -- of M1 will
increase at a faster rate than it baa on average during comparable periods of previous business-cycle expansions.
That
does not seem an unreasonable expectation, inasmuch as the
velocity of Mi has in fact been increasing more rapidly during
the current recovery than the historical r·ecord would have
suggested -- a development that reflects the increasing importance
of a wide range of substitutes for traditional checking deposits.
The Federal Reserve Board's staff estimates that the growing
use of such substitutes -- for example, NOW accounts, credit
um.on share drafts, drafts on money-market mutual funds,
passbook savings accounts for business firms and State and
local governments, and telephonic transfers from savings to
checking accounts -- depressed the rate of growth of M 1 by
about 1-1/Z percentage points in 1976. This year the impact
may be smaller but nonetheless will remain significant.
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The relationship between monthly or even yearly rates
of monetary expansion and the performance of the economy is
subject to considerable uncertainty under the best of circmnstances,
In the current environmeiit of rapid change in
methods of carrying on financial transactions that uncertainty
is heightened.
Co:tisequently, the Federal Reserve will
continue to maintain a posture of vigilance and flexibility in
the period ahead,
Current monetary policy represents our
best judgment as to what is appropriate in the light of evolving
economic and financial develoFents.
We will not be slow in
modifying that policy if actual conditions deviate materially
from our expectations,
In concluding this report, I think it appropriate to
emphasize the great complexity o( the econom.ic problems
currently confronting our Nation,
There are no instant, easy
solutions that will deliver us from our difficulties.
For our
part, we at the Federal Reserve know that inflation ultimately
cannot proceed without monetary nourishment,
But we also live
with a realization of our limited capacity to move dramatically or
quickly in making means of financing less readily available,
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The shock of abrupt adjustment after so many years of druglike abuse of our economic system would be excessively risky.
To the maximum extent feasible, however, we are determined
to move toward reestablishing conditions of financial order in
our society.
That is not because financial order is itself an
end with which we are preoccupied, but becauae our Nation
cannot realize its potential for sustained prosperity and wellbeing until existing apprehensions about inflation are subdued.
We at the Board have no illusions about what the Federal
Reserve alone can accomplish.
Sound monetary policy is a. pre-
requisite to the achievement of the employment and price goals
set forth by the Administration.
critical.
But other elements are no less
The President's timetable for eliminating the deficit
in the Federal budget deserves the earnest support of the Congress.
Structural rigidities that are weakening our economy also require
serious attention.
It is fortunate that members of the Congress
increasingly perceive that persistent budget deficits and ever
faster increases of the money supply, whatever their usefulness
in the past, are no longer capable of solving our economic
problems.
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Chairman MITCHELL. Thank you very much, Governor.
I have three quick questions. Referring to page. 3, you indicate that
money growth bulges of a month or two are often reversed subsequently. Why does _this happeni How does the reversal take J?lacei
Does it happen by itself or does the Federal Reserve do anythmg to
make it happen i
Governor PARTEE. My reference there is to the possibility that it
would happen by itself. Remember, that what we are talking about are
rates of increase in the stock of money. If you get a rapid increase for
a bit, there's a good chance of a level off; that is, that there will be a
bulge when the increase occurs, and then the stock will remain at the
higher level.
There is always the possibility that there will be a month or two of
10 or 12 percent increases, and then a month or two with very little
increase .. Therefore, the possibility of this uneven pattern in the developing trend of money growth is one that would lead, I think, to prudence in taking monetary action.
If, however, monetary action is taken-that is, if we hold back on
the reserves and short-term interest rates are driven up-the effect of
this, according to our studies, will be to distribute the impact over 5 or
6 months after the change in short-term market conditions has occurred.
In that case, a bulge would 'be gradually taken out of the money growth
number over the next 5 or 6 months as a result of tighter market conditions. Thus, I am making the distinction between just the normal unevenness in the number and the characteristics, which are somewhat
similar, of the effect that we would expect from explicit monetary
action.
Chairman MITCHELL. Let me pursue that a little further. Again referring to page 3, the FOMC rejected a policy recommended by some
not to provide the reserves necessary to support deposit expansion
bulges.
Governor PARTEE. Yes.
Chairman MITCHELL. It seems to me as a consequence this 6-month
lmlge in the money growth has resulted. What happens is that consequences result if you provide reserves and they also result if you do not.
More specifically, my question is: What are the consequences or the
costs of providing reserves·, or of not doing so, when deposits expand
unexpectedly i
Governor PARTEE. The cost of providing the reserves, Mr. Chairman,
is that if this is the beginning of a real expansive move rather than one
of the aberrations I spoke of, you have lost progress in resisting it. You
permitted the increases to occur and it becomes harder to take them out,
if, in fact, it is a basic move toward speculative excessive expansion in
the monetary aggregates.
The cost of not providing the reserves is that it will cause a scrambling in the markets as the banks, after the fact, try to adjust their positions. After all, they must obtain the reserves. Without the provision
of more reserves banks then must rearrange their assets in order to
come up with the requisite reserves. So they scramble by selling Government securities and calling loans, and the result is a disturbance in
the markets and higher interest rates. If it has been a temporary or an
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36
unimportant expansion that has occurred in the money supply, those
disturbances in the market-those tighter conditions and those higher
interest rates-are not conducive to good economic progress. It is, as
you' said in your opening statement, the horns of a dilemma, since no
one can never know.
You see, after the fact you can look back and look at the series and
say: "Aha! there is where the basic shift occurred toward very much
more rapid expansion." But that's after th~ fact. When you are living
through the event, one has •no way of distinguishing really between
aberrations and more fundamental movements.
Chairman MITCHELL. Thank you very much.
Congressman Derrick?
Mr. DERRICK. Thank you, Mr. Chairman.
Governor, do you believe in the basis of 30-, 40-, 50-year economic
cycles?
Governor PARTEE. ell, I believe there is some basis for such long
cycles.
Mr. DERRICK. What's the name of the economist who developed
that? What I am getting around to is that I have seen some projections here just recently that indicate we are probably going to be stuck
in this country, at least Japan and the United States, with about 4
percent real growth over the next 10 or 15 years.
Governor PARTEE. Four percent, did you say?
Mr. DERRICK. About a 4-percent real growth. This would be tops.
Some of the other developing nations probably substantially less than
that. I noticed that President Carter, before the World Bank and the
Monetary Fund yesterday suggested that we were going to have a 6percent real growth in the next fiscal year.
I was wondering if you might comment on this. There are quite a
few, of course, who believe we are going to be saddled with this 4percent or less real growth and the corresponding unemployment,
about what we have or maybe a little worse over the next number of
years, certainly on through the 1980's.
Governor PARTEE. Mr. Congressman, I really think that my answer
should be divided into two parts.
Mr. DERRICK. Probably my question should be as well.
Governor PARTEE. No. 1, I believe the President was talking about a
period in which he expected to have more rapid than normal economic
growth in order to utilize the resources-unused plant and equipment
as well as unused labor-that exist in the economy. It is quite possible
to have for relatively brief periods of a year, 2, or 3, faster rates of
growth as the economy absorbs these idle resources; as the unemployment rate is reduced, if you will.
Mr. DERRICK. That same theory, as you know, suggests that we overbuilt during the 1950's and 1960's and this is where our problem is.
Governor PARTEE. I understand. The second point I would make is
that in the long run the prospects are that our economy·doesn't have
a growth potential much above 4 percent. The growth rate of the labor
force is on the' order of 11/2 percent per year or a little more perhaps
1¾ percent over the long run. The growth in productivity or output
per employee in the economy is on the order of 2¼ to 2½ percent per
year. And since real output can only grow as fast as the labor force
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Federal Reserve Bank of St. Louis
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37
and productivity grow, the total comes around to about 4 percent per
year in the long run.
Now, as :far as long range cycles are concerned, there are tendencies
in the short run, the intermediate run-which is called the kitchen
cycle, I think-and the long run toward repetition. The long run tends
to be characterized by periods of invention and innovation that wear
themselves out, and a building cycle which tends to be quite long run
in character.
I don't believe in the inevitability of cycles. I think that that sugO'ests that man can't deal with sources of instability through thinking
~nd reasonino-. I have never felt that there ,vas anything inevitable
about cycles, '"'even though one can see periodic_ episodes in history. I
don't think that means we have to have them 111 the future.
Mr. DERRICK. Assuming that you feel that the 4-percent real growth
is realistic, how does that-give us an unemployment figure in there
somewhere.
Governor PARTEE. At a 4-percent real growth rate, the unemployment rate should remain about unchanged. That was the basis of my
comment; that is, for a while there can he a faster rate of growth as
idle labor is utilized, and the unemployment rate would he dropping.
After a point, there would be a more stable growth rate of around 4
percent and the unpmployment rate would change very little.
Mr. DERRICK. Do you think we are probably going to have to learn
to live with an 1mPmployment rate of about what we have on the average during the eighties?
Gowrnor PART'EE. I don't think we should.
Mr. DF,RRICIL I don't think we should either. ·what I want to know
is do you think we may be faced with that-that there is a strong
likelihood?
Governor PARTJ.;1,;. My own view is that the economy is not working
now at anything like its optional level, that there's considerable progress that can be made in getting hight>r output given the capacity and
the capital and the labor that we havt>, and that such progress would
bring the unemploymt>nt rate down some.
I think also there is a very real need for structural programs to
reduce unemployment in those areas where it is so persistent.
Mr. DF.JmICK. Such as?
Governor PARn:E. Massive training programs for people who don't
have the skills that would make them employable, and other programs
that would make them better workers.
Chairman Burns has often mentioned job banks; and I think that
has ~ot something. '~here is a n_eecl to match up the unemployed with
the Jobs that are available. I thmk we could do more with that. There
could also be more regional movement of people from one place to
an?ther in order to fill v~cancies that develop. There are a great many
thmgs that could be done 111 that area, sir.
Mr. DERRICK. One more question, 'What jobs are going to be available for these structured programs? That seems to me to get back to
!he whole crux of ~he thing unless we have some sort of public work
Jobs, or make-work Jobs.
Governor PARTEE. I am talking about making people more employable at various levels of skills, starting at very low levels. If you look
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at the record of the recovery period, you will find employment has increased very sharply across the board, more sharply than it has on average in postwar recoveries. We have generated a great many jobs. We
can generate a great many more. But I would, myself, much prefer that
.they be jobs that people can take as a result of retraining rather than,
as you say, public service jobs that are probably deadends and won't
really prepare people for other kinds of productive work.
Mr. DERRICK. Thank you.
The Chairman has kicked me three times under the table. I guess that
means my time is up.
Chairman MrrcnELL. I am not even capable of doing that.
Mr. Caputo~
Mr. CAPUTO. I got the impression that it was your view that the
expansion in the monetary aggregates was at best acquiesced to by the
Fed; they didn't initiate it, and it may be transient. The larger aggregates may not have gone up beyond recent growth rates at all. The adjusted Federal Reserve credit numbers, which are largely reflections
of voluntary, discretionary action by the Fed in that you can choose
to buy securities and choose to let the float expand seem to have accelerated in the last 12 months also.
Governor PARTEE. Yes.
Mr. CAPUTO. Which would be a monetary decision.
Governor PARTEE. I don't think it is, Mr. Caputo. I don't think it is
voluntary because, as I said before, if the way that holders' demands
and preferences are worked out results in an increase in currency and
demand deposits, then the choice that the Federal Reserve has is either
one, to provide the Federal Reserve credit, because the Federal Reserve credit makes available the reserves that are required to support
either the currency or the bank deposits, or two, not to provide it and to
force those currency or deposit totals back down again. So it is not
voluntary in the sense that we just decide in the abstract that, yes, let's
provide some more Federal Reserve credit. It falls out of what's happening in the private sector in terms of demands for various kinds of
money and deposits.
Of course, we certainly could have done it. We could have failed to
provide the credit and we could have forced a downward adjustment
in the amounts the private sector desired to hold.
Mr. CAPUTO. I just wanted to be sure you had control over that.
Governor PARTEE. If we wanted to.
Mr. CAPUTO. Let me ask also: I share your concern for your problem
of trying to identify how interest rates affect economic statistics at any
point in time, especially the short run, where you are called upon to
make that relationship. It seems to me that interest costs have at present marginal impact on the decision to invest in job-creating business
activity. Uncertainty about energy policy, tax policy overwhelm onehalf percent differences in the interest rates. Is that your view? That
small changes in the interest rate are not likely to change in one way
or the other job-producing business investments at this time i
Governor PARTEE. Business investment-that is spending on plant
and equipment-is probably not as responsive to interest rate changes
as are other sectors of the economy. As you indicated there are so
many other considerations in the investment decision. Also, interest
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is a before-tax expense and, therefore, there is a tax benefit-in effect,
the Federal Government pays half of the cost of the interest, assuming it is a successful business.
I have always held that most businesses do consider a range of
possible investment expenditures that will yield different calculated
rates of return, and that if we move interest rates up significantlyand half of one percent may not be significant-that will cut off some
of the lower yielding planned expenditures. If you reduce rates significantly, it will make possible some of the lower yielding expenditures.
But changes in interest rate have other effects on the economy.
__
There seems to be a fairly definite relationship between interest
rates and the performance of the stock market, for example, because
the alternative to investing in stocks is to buy bonds. If bonds yield
more, they are more attractive. If they yield less, they are less attractive. Changes in interest rates tend to direct money between those two
markets and thus affect the performance of the stock market.
Mr. CAPUTO. Why should we be worried about that?
Governor PARTEE. Because our econometric studies have suggested,
and I think it is probably true, that the way consumers perceive their
real wealth-that is what they feel their total financial wealth to ·beaffects the way they spend.
Mr. CAPUTO. Why does the mix between debt and equity affect their
real wealth ?
Governor PARTEE. The stock market represents a substantial store
of value at market prices to consumers. Therefore, if the market goes
down, consumers will feel less inclined to spend, particularly on durable goods. If it goes up, they will feel more inclined to spend.
I think also that interest rates have a considerable effect on inventory policy. For there, too, interest is a calculated cost of carrying
inventory ·as against the calculated rate of return resultine: from
expected inflation and avoidance of bottlenecks and that kind of
thing that the businessman has to consider in deciding inventory
policy.
Finally, I think there is no question that interest mtes considerably
affect the demand for housing, and, therefore, substantially higher interest rates will tend to choke off housing starts while lower interest
rates will tend to encourage them.
There is a whole range of effects on the economy that can work
through interest rate changes.
Mr. CAPUTO. So, for purposes of unemployment, we should be concerned about small changes in even short-run interest rates?
Governor PARTEE. Now, you changed the terms on me in two ways.
You say small changes rather than substantial. Second, you say even
short-term rates. I think short-term rates are of much less concern
than long-term rates in terms of their effects on the economy.
I don't think the 150 basis point increase in the funds rate that we
have had so far had any significant choking effect on demand in the
economy. But I wouldn 1t say to you that 250, 300, or 400 basis points
would have no effect, partly because as those short rates rise, the direction of savings flows will change away from the thrifts and banks
into the market, and thus would reduce the quantity of mortgage
credit. Also, if those short rates rise substantially further, there is
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going to be an effect on long-term interest rates. So :far, long-term
interest rates have not increased. On balance, really, they have gone
down a little although short rates have risen some since March. But
sooner or later, if short rates rise substantially, our experience would
suggest that the long-term rates would increase.
Mr. CAPUTO. My time has elapsed. I want to make a concluding
statement for myself. Unfortunately, you don't have time to answer it.
The kinds o:f ranges, the kinds o:f interest rate changes that we have
observed are unlikely to have had an adverse effect on economic
activity.
Instead, there are problems with energy and uncertainty about taxes
and balance-of-payments problems.
Governor PARTEE. I agree.
Chairman MITCHELL. Mr. Hannaford?
Mr. HANNAFORD. Thank you, Mr. Chairman.
Governor, it is unusual :for short-term rates to be rising when business activity and inflation are slowing. How do you account for this
happening at the present time?
Governor PARTEE. Well, Mr. Hannaford, the slowing of the inflation and the growth in the economy is a pretty recent development.
One of the principal things that happened this year was that in the
first hal:f, there was an acceleration in the economy's growth and there
was an acceleration in the rate o:f inflation. The more rapid inflation
was due to food and energy prices going up, with an underlying inflation rate that seemed to continue along about the 6-percent level. It
may well be that what we have seen through the spring and the summer has been a reaction o:f short-term rates to the credit demands associated with that strengthening in nominal GNP that occurred in the
first half o:f the year.
It is really only the third quarter, maybe even only August and
September or perhaps October, where we are talking about a slowing. It is so recent that I don't think it can have communicated itsel:f.
Now, if that slowing should continue for an appreciable period, or
extend itself into even more slowing than we have seen so :far, I think
it would have its effect on rates.
One reason, I think, that long-term rates haven't increased over
this ,period is that the market is anticipating that there won't be
excessive expansion in the economy in the period immediately to come.
Mr. HANNAFORD. Thank you.
If I could turn to Congressman Derrick's question about long-term
cycles, and as described long-term cycles to external forces, such as
waste of activity and invention.
Governor PARTEE. The long cycles are generally thought to be those.
Mr. HANNAFORD. Would it not be true that the long-term lag that
he suggested is due to the continuing increasing costs of energy to a
large extent?
Governor PARTEE. I think the change in the price of energy has
been a major development :for the world economies. But I don't know
whether we can say that there has been an important lag introduced
by that. Energy is a :factor of production, and that means that one of
the costs of the factors of ·production has gone up substantially. There
could be adjustments by shifts away from energy use to other factors,
without much of a lag.
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Mr. HANNAFORD. A very simple example, an increase of imported
energy-Governor PARTEE. Yes.
Mr. HANNAFORD. Particularly, ,perhaps domestic to some extent,
would have the effect of a surtax in that amount, just sucking it out
of the flow of the economy.
Governor PARTEE. That is true.
.
Mr. HANNAFORD. This is something we really haven't experienced
before, I don't believe. We dealt with it in our .history. What policy
should we pursue to recompense that?
Should it be an effect in monetary policy or an effect in fiscal policy,
or should we just throw our -arms up over our heads and survive it?
Governor PARTEE. That's a very important and deep question you
have asked.
My answer is that if we have had a. shift in the direction of funds
that results from much higher energy prices-both shifting income
away from consumers and in the direction of business, and shifting them away from domestic business to foreigners, which was your
important ,point-that has to be compensated for principally through
a changed fiscal policy.
Let me make one more point. This is such an important question.
To the extent that higher foreign oil prices have resulted in a higher
general level of prices from that exogenous force, then we can't easily
take care of this with domestic monetary adjustments. You would
have to have a somewhat higher monetary base for the economy than
you would have had in the absence of the oil price hikes. Otherwise
what one is saying is that we a.re going to force reductions in prices
on other sectors of the economy by holding down the monetary base,
in order to compensate_ for the increase in price that has occurred
in oil and gas and that kind of thing.
It seems to me that that is pretty stiff medicine for the economy to
take. So far as economic activity is concerned, it seems to me that a
fiscal policy response is what is called for.
Mr. HANNAFORD. I am sorry for straying somewhat from the immediate question at hand, but that is the question we are going to
be dealing with for the rest of this century, I think. Relationship
is important.
Thank you. I yield back my time.
Chairman MITCHELL. Thank you.
Mr. Barnard?
Mr. BARNARD. Governor Partee, in previous hearings this year, the
Fed has been somewhat criticized for keeping a restrictive monetary
policy during 1976. Does this criticism have any effect on the attitude of the Fed this year?
Governor PARTEE. Mr. Congressman, we always listen to all of our
cl'itics. I might say that, generally speaking, our critics have_n_ot been
on just one side of the issue. '\Ve almost always have some critics who
say we are too expansive and other critics who say we are too restric.
tive at any single poi~t -~ time.
Right now, the criticisms seem to be pa.rt1cularly marked. Comparing the recent publication o~ the so-cal_led 'Shadow 9pen ¥arket
Committee, a group of academic and busmess economists, with the
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report of the JEC that was issued over the weekend, one is really
pulled very strongly in two directions.
At the Fed we like to think that we are trying to do what is best
for the economy at the particular point of time in which we find
ourselves.
Now, I would say that the arguments that monetary polic,r was
restrictive last year were very much overdone. I don't think 1t was
nearly as restrictive as many said, and I base that conclusion on the
performance of the broader aggregates which were growing strongly
throughout 1976, the flows of funds in the economy which were rising relative to the GNP, and the performance of interest rates which
declined throughout most of the year.
So I think it is only in terms of narrow M1 that someone might have
concluded that there was restrictive policy last year. By the same
token, I don't think we have such an expansive policy this year. Again
it is a question of what you look at; if you look at the broader aggregates, as I said in my statement, you find the growth rates aren't going
up. In fact, the rate of growth of the broader aggregates is lower this
year than it was last year. If you look at interest rates, you see they are
rising-not falling-at least in short-term markets. If you look at the
flow of funds, which is the total flow of credit in the economy, you find
it has not risen significantly further relative to the GNP this year, after having risen last year.
Your conclusion about what kind of monetary policy we've had depends on how broadly you cast your net.
Mr. BARNARD. Do you think we are overreacting from the standpoint of the increase in interest rates~
Governor PARTEE. I <lon't believe so, Mr. Barnard. I think it's been
indicative that the long-term market rates have not risen significantly.
It seems to me that if market participants were anticipating a repetition of the sharply rising trend of rates of 1972-74, they would be
avoiding those long-term securities and the interest rates on those longterm securities would be going up sharply. I believe that the market
is taking what has happened so far with considerable ease. Perhaps
aplomb would be the best word.
The short-term rate increase is significant; that is, the 150 basis
points in the very short-term markets. That's about true of the very
short-term Treasury bills also. But the increase is not strikingly large;
and, of course, it would have had to have been considerably la.rger had
we kept the money growth rate down over this particular span of time
to the ranges that have been specified by the committee.
Mr. BARNARD. Governor, are you familiar with the minority report
from the Joint Economic Committee?
Governor P AR'l'EE. Yes. I only got it yesterday afternoon. I have
leafed through it. I haven't read it carefully, sir.
Mr. BARNARD. I was interested in Senator Javits' recommendation
that over a long period of time we ought to have a significant decrease
in monetary rates in order to offset inflation. Do you feel that is the
track we ought to take~
Governor PARTEE. I believe that approach is necessary to significantly reduce the rate of inflation. But it takes a long period of time,
because we have so many structural obstacles that have been built into
the economy which raise costs that result in the higher rates of infla-
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tion. Over a long period, I think both the expansion of our money
supply-broadly defined as being the kinds of assets that people have
that they can spend-and the expansion of the costs in the economy
have to be brought down together. I do believe that that is a proper
policy. It is a question of degree and speed, and whether you do it unrelentingly from quarter to quarter or whether you move back and
forth with the vicissitudes of economic developments.
Chairman MITCHELL. Would the gentleman yield?
Mr. BARNARD. Yes, Mr. Chairman.
Chairman MITCHELL. In your last answer you referred to a long
period of time. How long a time span are you talking about?
Also, I assume you would attempt to reduce these incrementally, say
quarterly, over that long period of time? I am not clear where you are
going with this. What are we talking about when we talk about "a
long period of time" 1
Governor PARTEE. I can't be very specific, Mr. Chairman, because
I think what it takes is a change in attitude on the part of the economy
that will lead to an acceptance of much lower rates of gain in money
incomes, because lower money income gains go along with lower
money growth.
What I mean is that length of time it will take before workers agree
to wage increases that are no higher than the productivity gains, about
2½ percent. How lorig will it take until we introduce into business operations the constraints that limit expected price increases in response
to cost increases that go on every day?
How long will it take before we get rid of the inflationary bias that
exists in hundreds of government programs? All that, I think, causes
:from the cost side upward pressures on the price structure; and all that
has to be brought down as we bring down the rate of growth in the
money supply.
How long 1 It is a very difficult question.
Chairman MrrcHELL. I thank you for yielding to me.
The answer makes it very clear to me that we cannot in the near future, even if we introduce all of those. variables, plot a time span when
this reduction would take place.
Governor PARTEE. I do think, Mr. Chairman, that we need a major
program to deal with the structural problems that lead to upward
cost pressures in the economy, as one of the major things to go along
with a gradual program of reduced monetary expansion.
Mr. BARNARD. Would taxes play a part in iti
Governor PARTEE. Yes; I think so.
Mr. BARNARD. Today, we have been discussing increasing productivity, reducing unemployment, reducing and maintaining a lower
rate of inflation ; but I think that one of the most important questions
we are going to be facing in the very near future is a significant personal and corporate tax reduction program to stimulate the economy.
It seems to me that what is presently being done is having only a slight
effect: The consumer has little confidence; the business community has
1ittle confidence. These are the hard problems we must face. What we
all want is a better economic recovery.
I have no further questions.
Chairman MITCHELL. Mr. Watkins?
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Mr. WATKINS. I have been sitting here giving it a little thought from
the standpoint of being a former home builder. I realize that the money
supply is increasing, but yet we are defeating the purpose on the other
hand when we see our interest rates increasing.
,:v.1iat do you predict the economy will do with the money supply
increasing and interest rates increasing as Mr. Barnard stated 1 I know
home building very well :from a firsthand experience and I use the
money supply as a gauge lots of times as a forecaster to the economy
so I know whether to move forward or hold back.
Governor PARTEE. Up to this point, Mr. Watkins, I don't believe
that the increase in interest rates has been significant enough to have
any material impact on the economy generally, or on home building.
If we look at the recent figures, we see still qmte a good rate of inflow
to the mortgage lending institutions, including the commercial banks.
We see commitments rising for home mortgages by all lenders, and
we see the rate of starts at very high levels. At this point there hasn't
been any undesirable impact, from your point of view, on home building demand.
However, if the economy continues to move ahead, and if the monetary aggregates continue to expand and therefore interest rates begin
to move up, we will begin to see limited prospects for further advances
in such fields as homebuilding. That has happened before, and I would
expect it would hwppen again.
I myself, looking at the statistics, don't see that we have that rapid
an expansion in the economy in prospect. I am hopeful that the behavior of the monetary aggregates which we were discussing earlier
today is in the nature of an aberration and perhaps a shift in holder
preference from one form of deposit to another, and not the beginning
of a major expansion in money.
I have to say to you that if in fact there's going to be a major accelerating expansion in money, defined in any of a variety of ways,
the Federal Reserve will have to move against it because it will be in
the long run inflationary for the economy. It will be in the long run
destabilizing for the economy.
·
But I don't yet find myself in the position of saying to you that
that is highly likely.
Mr. WATKINS. But have you run any studies on which ones are
more inflationary, in say, allowing interest rates to drop so businessindustry can go about expanding and building jobs in the private
sector versus the Government plowing billions of dollars into public
work jobs@
Governor PARTEE. ·well, I don't know of a study that has been done
that could specifically address itself to that question, because there
are cyclical movements in Government expenditures and private dem~nd. In the abstract, I would say that if one shifts resources to the
pomt where a much larger proportion of resources is going to the
Government for nonproductive purposes, the chances are that will in
the end be more inflationary, because it will collapse the availability
?f resouz:ces to build productive plant or basic additions to the economy
m the private sector.
We haven't seen anything of that kind, of that size. I had felt that
perhaps they would reach that stage in Britain, where the public sec-
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tor takes a very large proportion of the GNP of the country and a
very large proportion of all credit flows. So in the abstract, I think if
one identifies public spending as involving expenditures which don't
add to productive capacity, and private investment as adding capacity
to produce in our economy, then I would have to say that the public
spending in the long run will be more inflationary than the private
investment.
Mr. WATKINS. / agree with you. We are all delving :for the same
pot of money, whether it's for the Government spending programs or
whether it's for the business industries to expand.
Then we have a second factor oriented to production. We have got
a tremendous deficit of trade that's going to have to be offset some
way. Agriculture can do a large portion of it, but somewhere along
the line we are going to have to allow production in our ·private sector
to export more to offset this balance of trade.
How significant do you think that deficit will be 1
Governor PARTEE. The deficit has two effects on the U.S. economy.
First, the larger the trade deficit-that is, the more imports relative
to exports-the more you hold back the recovery of the domestic economy in the abstract. Therefore, the rapid expansion in the deficit over
the past year has in my view reduced the rate at which the domestic
economy has been able to expand.
The second effect, I think, is the financial effect. Although we finance
the deficit easily-that is to say, the dollar hasn't dropped significantly
relative to the average of foreign currencies-it does establish a whole
stock of short-term credits that foreigners have advanced to the United
States. It seems that will not be sustained. It will stop, be reversed.
It does produce, in my view, over the long run another potential source
of financial instability.
That is the way I would answer your question.
::\fr. ·wATKINS. Mr. Chairman, it has been brought to my attention,
that an article by Mr. Lindley H. Clark, Jr., in today's Wall Street
Journal is relevant to these hearings. I would like to insert that in the
record.
Chairman MITCHELL. It will be inserted.
[The article referred to follows :]
[From the Wall 'Street Journal, Sept. 27, 1977]
THE MONEY MESS
(By Lindley H. Clark, Jr.)
Today the House Domestic Monetary Policy subcommittee will open hearings
on the new money mess. Federal .Reserve Chairman Arthur Burns keeps saying
that the Fed has to slow the growth of the money supply if we're ever going to
overcome inflation, but the Fed keeps pouring out money faster.
. Mr. Burns f!et the maximum growth rate for Ml-currency plus bank checkmg accounts-at 6½ percent. For the past six months, however, Ml has been
expanding at an annual rate of more than 9 percent.
"We want to know whether recent monetary developments mark a change in
Federal Reserve policy and, if so, what the change is and what it is intended to
achieve," said Parren J. Mitchell, the Maryland Democrat who heads the subcommittee. "If recent money growth and interest rate developments were unplanned, we need to know what caused them and why the Federal Reserve has
been unsuccessful in correcting for them."
Chairman Burns has been invited to testify or send a representative.
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In a letter to Mr. Burns early this month, Henry Reuss, chairman of the full
House Banking Committee, charged flatly that the Fed has "lost control of the
money supply." The Wisconsin Democrat foresees dangers of accelerating inflation in 1978 and a deeper stock market slump as investors fear desperate Fed
moves to _get the money supply under control.
*
*
•
*
*
Last week the Shadow Open Market Committee, a group of private monetary
economists, was pondering the money mess. The group is composed of monetarists, economists who stress the importance of money-supply growth to shortterm economic trends. It meets twice a year to assess the Fed and its works.
At times over the past two years the group's verdict has been largely favorable.
After all, the Fed has been setting targets for moneta·ry expansion rates and
even showing some determination to stick to them.
Now, however, the Federal Reserve has painted itself into a corner. There is
simply no easy way out.
The shadow group, headed by Karl Brunner of the University of Rochester
and Allan Meltzer of Carnegie-Mellon University, said the Fed has three
alternatives:
It can continue on the path of rapid money growth that has prevailed in 1977.
This option, the group said, "minimizes the risk of recession in 1978 but would
result in increased inflation. By maintaining the recent high rate of money
growth, real growth might temporarily be higher than otherwise, but at the cost
of higher inflation later."
As inflation increased, demands would grow to do something about it. There
are no miracle cures for accelerating inflation. As Chairman Burns has often
pointed out, wage-price controls at best are no more than a temporary palliative.
Sooner or later the Fed feels compelled to slam on the monetary brakes and we
skid into another recession.
The second option is only slightly more appealing. We could in effect accept
this summer's errors and tell the Fed to go and sin no more. Starting with the
money supply at current levels we could slow future growth to an acceptable rate
within the Fed's own ta·rget range.
Such a rate, of course, would be well below recent levels. ,vhat it would
achieve, in all probability, would be a recession-accompanied by the inflatio.n
already purchased with recent excessive monetary growth. Eventually, though,
the economy would get back on track.
The third option is more complicated but probably more useful. 'l.'he J<'ed could,
in a short period of time, merely lop off the summer bulge by reducing the money
supply by $4 billion. It should, at all time, announce what it's doing and why.
If this were done, the shadow committee is convinced that the effect on economic growth would not be severe. The economy so far has not had time to
adjust to the higher money-supply levels that now prevail.
After the once-for-all adjustment in the money stock, the shadow group says
the Fed should resume the expansion of 1\11 at a constant 4½ percent annual
rate. For my part, I wouldn't quibble too much if the Fed kept the growth rate
within its own target range.
*
*
*
•
*
*
Option three is not one that is likely to appeal to the Federal Reserve. In
fact, if the Fed clings to its current operating methods, the once-for-all adjustment would be difficult to achieve.
At present the Federal Reserve plays a little guessing game im·olYing interest
rates. One interest rate that the Fed can control effectively for short periods of
time is the rate for Federal funds-the reserves that banks lend one another for
brief intervals.
If the system wants to cut the Fed funds rate it simply creates more reservesfor example, by purchasing Treasury securities. A larger supply tends to depress
the rate. Conversely, the Fed tends to push the fed funds rate up by reducing the
supply of reserves-by selling Treasury securities, for instance.
The Fed funds rate is always known. So the Federal Reserve asks an econometric model what funds rate is consistent with the monetary-growth rate it
seeks. The trouble is that the model keeps coming up with the wrong answers ;
that's one reason why the Fed, lately, has been pumping too much money into
the economy.
•
•
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Federal Reserve technicians in time could adjust to the wrong answers. This
year, however, they apparently have been reluctant to do so, since the adjustments have meant that they have had to accept somewhat higher Federal funds
rates. Faced with the choice the Fed has elected to let the money supply get out
of control.
In the current uncertain economy the Fed's performance has been irresponsible.
Now it's time for an explanation.
Chairman MITCHELL. Bear with me for just a moment. Mr. Hansen
has some questions.
e have other witnesses. There is one question
I want to put to you after Mr. Hansen's time. You might be thinking
about it.
In the Wall Street Journal article being inserted in the record,
Chairman Reuss says, very flatly, that the Federal Reserve has lost
control of money flow. Without speaking directly to his accusation, I
would Jike to know, after Mr. Hansen's questions are raised, what specifically does the Federal Reserve plan to do to get the money supply
back into the targets that were clearly established at the beginning of
the year, targets suggested by the Federal Reserve and agreed to by
the Congress?
I am a funny kind of guy. I have to know in specifics what you intend to do, how you intend to initiate some sort of serious efforts to
get back to the targets that the Federal Reserve established as its own
targets for this year.
Mr. Hansen~
Mr. HANSEN. Thank you, Mr. Chairman.
When you have a bubble or balloon created advertently or inadvertently with regard to money supply, what's the lag time of effect
as far as what it does to the economy and what's the lag time of effect
as far as corrective measures that are taken to offset it by organizations such as yours?
Governor PARTEE. Well, Congressma,n, first of all, it may ha that
the bubble results from just a, technica,l shift in the funct!911, iilwhich
case it has no effect on the economy and doesn't realJy -need to be ta,ken
care of.
If, however, it is not a technical change in relationships that has occurred, there is a distributed lag effect on the economy-both on the
real economy and on the rate of increase in costs and prices. We have
generally felt the effect on the real economy occurs in the earlier part
of the lag. The effect on prices and costs occurs later on, say, after 1
years or so, if when this bubble occurs we are not operating at capacity
In the economy, which we haven't been.
Our own lag structure of reaction is made up of two parts as we see
it. First, it's a question of the length of time it takes us to change
market conditions to a, point at which they will successfully resist the
increase in the average level of the money stock, or whatever monetary aggregate you are talking about. And, second, there is the lag
that occurs with regard to the public's and the banks' adjustments
tha,t take place in response to those different market conditions.
I would say that the first lag is relatively brief, certainly countP.d
in terms of weeks or 1 month or 2. The second lag, as I stated earlier,
we believe.fo extend over 5 or 6 months. Thus, if you do get a real
shock to the money supply, and you might well characterize the April
a,nd July bulges put together as a real shock, the chances are it would
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take 6 or 9 months to wash it out subsequently, without doing great
damage to the economy. That is, it would take 6 or 9 months to wash
it out as one looks over the aggregates.
Mr. HANSEN. So what we are saying, then, regarding some adjustment to the economy, at least through the supply of money, is that you
can have some effect within weeks or at least a few months through
this type of adjustment as opposed to trying to influence the economy
with tax credits and various other things which can be something
that sometimes takes years?
Governor PARTEE. I think the lag time is longer on most fiscal policy
actions; yes.
Mr. HANSEN. When you talk about stimulating the economy from
our vantage point, can the Fed give enough adjustment? Can you give
enough adjustment in tax credits or various other governmental actions really to offset an economy that may be so laden with regulations
and requirements on business that you are almost taking the resiliency
out of it? In other words, can you give the businessman enough incentive by minor adjustments or even some major adjustments to offset
the fact that he's doggoned near out of business with the overhead
and the regulatory requirements he has to live with in order to be
in business ?
Governor PARTEE. Well, it is difficult, Mr. Congressman. At times I
think the economy is more receptive to getting the kinds of medicine
that will increase the rate of expansion. At other times it is less receptive. Certainly the receptivity of the economy to Government
action is affected by redtape, pollution controls, environmental controls, work requirements and all of the kinds of regulations you are
talking about.
There might be social benefits involved, but just looking at the economic side of it, one would have to conclude that that system of controls and regulations, as it becomes more extensive, does tend to reduce
the receptivity of the economy to expansion.
Mr. HANSEN. Well, I was thinking-and I don't mean to make an
unfair analysis of this, Mr. Chairman. I sometimes liken the Fed to
the tail on the dog, the Government dog, so to speak. I think too often
you are expected by one group of people to be able to make adjustments
that would change things markedly and greatly as far as the economy
and management of the money supply and interest rates are concerned.
You are even expected to make adjustments which really are not in
your realm and which perhaps are more in the realm of the Congress.
On the other hand, some people who don't like adjustments by the
Fed blame you for things that really the Congress is responsible for.
I think too often the heat is on you to do things that really are more
in our realm to do or undo in the sense of making a better business
·climate-a better climate for employment and so forth.
A lot of times we hear, Mr. Chairman, about increases in wages and
so :forth being inflationary. Perhaps they are to a degree. However,
the most inflationary thing we have, the problem that is conducive to
keeping business sluggish and slowed down, and keeping us from
having jobs and prosperity, is too darned much government; too many
regulations. We find ourselves heaping this massive burden on business
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and then trying to undo it by a tax credit, an interest adjustment, more
money supply, or something else.
I believe we have to address ourselves, if we are out to help the
workingman, to establishing a business climate in this country where
a businessman can function without being so much under the gun
that when you give him an adjustment, it isn't enough of a gasp of air
or oxygen that he can respond significantly to it.
I think maybe, just maybe, the administration said it all recently
regarding OSHA being the best example of massive overreguYation
and still not accomplishing what was desired in the field 9f health
and safety.
I am wondering if we don't need to really take a good look, although
it is not our capacity in this committee or subcommittee, but a good
look at what we are doing to the business climate and the agricultural climate in this country in terms of regulations, demands on
business, and so forth.
I am not saying we don't need to regulate to a point of keeping
people safe and keeping circumstances adjusted properly, but I believe we need to take a good look at what we have done. I can tell you,
Mr. Chairman, for instance, on safety-and that is probably somebody's sacred cow-but we have workmen's compensation, liability insurance, State and local health inspectors, fire inspectors-every kind
of inspector. Now we have the Federal Government in on it, and it is
heaped on and heaped on, patchwork after patchwork.
Then we go to the businessman and say, here you are, Mr. Businessman, we have some paper here--paper to shuffle. He then puts on three
secretaries to take care- of something when one secretary ought to be
abfo to do what it takes to run a business. And again we come along and
say we wil:l gi vc you a tax credit of so much, and he is supposed to respond to this. Can he?
Chairman MITCHELL. The gentleman's time has expired.
Mr. HANS1',N. I understand that.
I would like to ask you, Governor, in your expe,rience, do you find
you are sometimes fighting a wall when you are tryin~ to make adjustments? Do you think you are being expected to do something impossible because of the structure of things'?
Governor PARTEE. Yes, Mr. Hansen. Your comments have really
gone well beyond my field of expertise. I certainly agree with one-Mr. a:ANSEN. Gone beyond the purview of this subcommittee, too.
[Laughter.]
Governor PARTEE. I would like to say one thing. I think people
often put too much emphasis on monetry policy as the principal factor
that can change all of the economic prospects we have and all of the
economic arrangements we have. I do believe, as I said earlier, that
we need to make, progress with our structural problems--of which you
certainly mentioned a number of important ones-that would go along
with a proper monetary policy to reduce and elimin'ltc the inflation in
the economy. Otherwise we are fighting a war of inexorable cost increases which mean, I think, that moving to a noninflationary rate of
monetary growth would do great harm to the real economy, because of
those structural effects that raise costs and keep costs rising more
rapidly than productivity in the economy.
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Mr. HANSEN. Mr. Chairman, I put the gentleman on the spot a little
bit, 'hut it concerns me about hearings that sometimes we get looking
only at one line of attack on the adjustments we need. I appreciate
your indulgence and hope we can keep this, the whole problem, in
perspective. It's futile to try to solve the whole problem having only a
handle on one little corner of things. Thank you.
Chairman MITCHELL. Fine. I am glad that you spoke as you did.
It points up the criticalness of the question that I have raised. What
we have done in this Congress in an effort to get a handle on Government spending is to establish a Committee on the Budget which works
in concert with Ways and Means, Appropriations, and all the other
major committees. Key to that working relationship is the understanding of monetary policy established early in the year.
Now, without in any way attempting to place an undue burden on
Governor Partee or the Federal Reserve, my earlier question goes to
the issue that if there is a commonly agreed on monetary growth policy
at the beginning of the year, then al1 of us-banking, budget, aH o.f
Congress-operate roughly within those guidelines established by you
and accepted by the Congress. To the extent and degree that you move
away from those guidelines, you throw this who[p, delicate balance out
of whack. That is why I posed that question to you.
Y 011 are out beyond the guidelines that you established. What do you
intend to do to get back within them? How and when? By what
methods?
Governor PARTEE. Mr. Chairman, you put me in a very difficult position because you are asking me to speculate. about the future. I can't
do that. That is, you are asking me what future actions the FOMC
will take with regard to money markets and open market operations in
order to achieve some particular range of growth in the aggregates.
I would also point out that we have never referred to the long-term
growth rates for the monetary aggregates as targets. We have always
referred to the ranges of growth of the agigrega.tes as those that we
thought at that point in time, seemed appropriate to the needs of the
economy. The reason that we come up quarterly to testify at the oversight hearings is to hold open the option to change our views, because
of what's happened in the economy, as to what the aggregate performance ought to be. So you see, not only can I not answer your question,
because the FOMC has not had the meetings at which it will make
those determinations, but you are asking a question that is associated
with the quarterly overEight hearings.
Chairman MITCHELL. Then, Governor, are you saying-and I don't
want to misinterpret you---in effect, that the money growth targets,
particularly, M1, M2, mutuaHy agreed upon by the Federal Reserve
and the Congress, are really meaningless? Is that right?
Governor PARTEE. No, I don't think they are,. I think they indicate
the drift of current thinking. And I think that there has to he significant reason and significant understanding in changing them, but I
just can't say that they won't be changed, because that might occur.
I would say one thing to yon, Mr. Chairman. I remember I said that
our conception was that there is a lag structure of adjustment to the
kinds of short-term money market conditions that we establish. We are
talking about a system in which in a matter of a relatively few months,
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5 months or a little less, the, funds rate has gone up by 150 basis points
or so. That lag structure has not yet fully worked. I wouild take the
position that we have already done quite a bit to reduce the future
rates of growth in the aggregates by our actions over the spring and
summer.
Whether it is enough or not, I can't say, because I just don't know
how the economy will perform and I don't know, as I said in my
statement, whether there are some technical aspects to the movement
of these aggregates that will be reversed in the period to come. I just
don't know whether we've done enough or not. ·whether or not the
longer-term ranges that the committee is seeking will be changed, I
also don't know.
As I stated before, M1 , which has been the point of emphasis in
all of this discussion, is the aggregate that is moving substantially
beyond the projected range. The other aggregates are only modestly
over. We use them because we feel that there needs to be a family of
them so you don't over rely on only one where there may be technical
factors affecting its performance.
They could very well drop back down within the ranges that we
have posted over the remaining 6 or 8 months that we have to run in
the year's period. I don't think that the evidence is clear that we are
going to substantially exceed the growth ranges for the family of
aggregates that were stated by the Chairman in the July meeting.
Chairman MITCHELL. I won't raise any more questions. However,
my hunch is that at the end of the next 6 months, we are going to find
that we have consistently exceeded the target you set. That is, indeed,
in my opinion, disruptive to the fiscal policy planning process, and to
business and consumer planning as well.
Governor PARTEE. Yes, sir.
Chairman MrrcHELL. Mr. Watkins~
Mr. WATKINS. Mr. Chairman, if you will yield, I would like to pose
the question a little differently and get back to your original question.
Governor Partee, i'n your thinking, what caused us to have this bulge
and to get out of the limits that you actually set for yourselH
Governor PARTEE. If I might amplify my point on substitution
which is in the testimony , there had been a great movement by holders
away from cash balances-that is, currency and demand deposits-in the direction of substitutes over the period 1975, 1976, and perhaps
early 1977. These substitutes included such things as the growth in
savings deposits of business firms, which had not been permitted until
the end of 1975. ,ve think that those savings deposits of business firms
came in part from what otherwise would have been in demand deposits.
The regulatory authorities allowed State and local governments to
have savings deposits, beginning in the late part of 1974. These also
moved up from zero--because they had been prohibited earlier-to
several billion dollars in the course of a short period of time; and we
think they probably substituted in some measure for demand deposits.
We had the development of NOW accounts in New England which
are not counted in the narrow money supply. We had the development
of things like automatic or telephonic transfer of balances-Perpetual
Savings & Loan advertises on the television that they do this. That
is not included in the narrow money supply. We also had a very sub-
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stantial growth on the part of banks in financing through RP's and
financial funds obtained from nonbanks in 1975 and 1976.
But now we think that it may be that what you are seeing in these
changed growth rates of M 1 versus M2 and M 3 is a slowing or a halting
for the time being of that tendency to shift away from demand deposits, that structural shift that was taking place over the past few
years. That may be a major reason for the increase that has occurred.
Chairman MITCHELL. May I interrupt for a moment again i
We planned our next set of witnesses to begin at 10 o'clock. I would
like Mr. Watkins to conclude his other questions, if they can be
answered succinctly.
Further, I would like to indicate that all of us have additional questions that we would like to have answered, and, obviously, we would
like to submit them to you for reply in writing.
Governor PARTEE. I will be glad to try to answer them.
Chairman MITCHELL. Proceed, Mr. Watkins.
Mr. ,VATKINS. Would you define what the causes are, which I guess
is past history i
Also what are the alternatives in getting it back within the guidelines i
That doesn't put you "on the spot;" does it i
Governor PARTEE. Mr. Watkins, the answer to that, as I said before,
is that we have tried to hold back on the provision of reserves. In the
course of that, the Federal fund's rate has gone up 150 basis points.
We feel that will have some effect-not only has had some effect in the
last relatively few weeks or month or two, but will continue to have
an effect for some months to come.
If, in fact, that does not do the job, then the Committee-not me,
the Committee-the FOMC will have to decide what further action,
if any, it wishes to take.
Mr. WATKINS. Not all of it is bad. Don't get me wrong. I see business and industry needing the inventory to work with.
Chairman MITCHELL. Governor, thank you very much. You have
been very informative. ,ve appreciate your taking the time to be with
us this morning.
I will ask the next three witnesses to come up so they can be seated
together.
Gentlemen, thank you so very much for taking time out of your
crowded schedules to be with us. I think you can see from the questions posed by the members of the subcommittee that there are serious
concerns about the rate of monetary growth and its impact on the
economy. This is a democratically run subcommittee.
e welcome
you. Any order in which you wish to speak, is fine with us.
Gentlemen i Dr. Gibson"i
,v
STATEMENT OF DR. WILLIAM GIBSON, VICE PRESIDENT, AND
MANAGER, FIXED INCOME RESEARCH DEPARTMENT, SMITH,
BARNEY, HARRIS, UPHAM & CO., INC.
Dr. GrnsoN. Well, thank you, Mr. Chairman. It is a pleasure to be
here. It was a pleasure to hear Governor Partee. He announced that
the Federal Reserve listens to its critics. I gather he figures I am not
going to be critical since the Federal Reserve contingent has left.
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The monetary sector is having a distorting influence on the economy.
The money supply is rapidly rising and short-term interest rates are
steadily climbing. We are accustomed to £ea,ring one or the other 0£
these situations.
Now, we have both. I think it is a situation that we should not let go
on much longer.
The money supply is increasing £aster than the economy can stand
and £aster than the Federal Reserve has said is appropriate.
It is $3 billion above the upper end 0£ its announced tarl,{et range.
Likewise, short-term interest rates are jumping very rapidly. In fact,
events have kind 0£ overtaken all our prepared statements. Yesterday
they had risen 175 basis points or a shade higher, rather than the 150
we had more or less gotten used to. They keep going up. All this is not
supposed to happen.
In consultation with you the Congress, the Federal Reserve has
pledged to keep the money supply at a lower and more stable growth
pattern than this. As all parties agree, the Fed and the. Congress alike,
sustained monetary growth at high levels is detrimental to inflation
in the course 0£ the economy and its stability. In its original resolution
on the subject in March 1975, the Congress said that greater stability
in monetary policy would lead to greater stability in interest rates.
I think that this congressional position is correct.
What has happened then?
In the first quarter of this yea,r the money supply was weak. It was
actua1ly lower in the last week of the quarter than in the first. The
Federal Reserve took no actions to increase it during the quarter-it
left the Federal fonds rate at 4% percent, the .rate at which it began
the quarter. Then in April money started growing rapidly, and in May
the Federal Reserve began trying to counter this. It has raised interest
rates more or less steadily since then. But still money supply is growing
too fast.
The Federal Reserve has not announced that it has let the money
grow £aster than target because the economy needed £aster money
growth. It has said to the Congress that 4 -to 6½ pe-rcent growth was
what the economy needed. The economy may need more, but this has
not been a motivation for policy. It w'as hinted at this morning but
only hinted.
Further, I do not believe that what has happened in the monetary
sector is what the Federal Reserve wanted. Rather, I think it crept
up unexpectedly. It is not, however, something which was unavoidable.
We got to the present situation as a result 0£ two factors. Fi,rst, thll
behavior 0£ the money stock in the first quarter was strange. Second,
the Federal Reserve was reluctant to raise interest rates rapidly
enough. Money's flatness with flat interest rates was more like a
symptom 0£ a weak or declining economy rather than one expanding at
twice the average rate of real growth.' Money was flat when overall
short-term credit to business expanded at a 5-percent annual rate. In
part, I think that this resulted from poor seasonal adjustment 0£ the
data.
I urged this subcommittee in another session to take a much closer
look at the way in which these data are adjusted. While very technical,
these procedures have a real-world impact on the execution and impact
0£ monetary policy.
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The other fact was the Federal Reserve's reluctance to control the
increases in money once they began for fear of pushing interest rates
up too fast. In the end, the Federal Reserve probably had to see rates
rise more than they would have, had action to control the money stock
been taken earlier. Cenkal banks around the world have traditionally
been hesitant to raise or lower-but especially raise.-interest rates
quickly for fear of upsetting financial markets and disrupting business activity. The Federal Reserve is not immune to such concerns,
and from time to time this caution has been encouraged by some voices
in Congress as well. When the Federal Reserve has delayed controlling
money at such times lest interest rates rise too much, they have commonly risen more than they otherwise would have, as inflationary expectations flared up in the interim.
I would like to comment on this reluctance to see interest rates move
from the standpoint of financial markets. These markets are becoming
more knowledgeable about monetary matters.
The past 3 months has been a very interesting period. Markets are
becoming more knowledgeable about monetary matters. They are looking beyond the perspective -0f the next 2 months. Financial markets
generally prefer stable short-term interest rates. But at times they
do not. The main of these times is when the money supply is rapidly
growing. Markets now recognize that if the price for stable short rates
is accelerating money growth, the comfort for the market is a fleeting
one. There is a growmg recognition that rapid money growth leads to
rapid inflation eventually, and this is definitely not a comfort for
markets. Indeed, many investors viewed the monetary situation in
July as threatening enough to plan to sell long-term securities if
short rates did not begin to rise soon to control the monetary expansion. They were concerned with the longer-range implications of an
accelerating supply of money.
The :fact that this market concern was not just imaginary was shown
in August, when short-term interest rates did begin rising as part of
the Federal Reserve's efforts to control money. Accepted wisdom from
earlier years would have predicted harmful effects on bond markets
from the August move in the Federal funds rate from 5% to 6 percent.
Virtually no one would have ever predicted that such a move would
be good for long markets.
But that is exactly what happened. Market conditions were never
really unsettled, and at the end of the month, long-term interest rates
were somewhat lower than at the beginning. ~farkets are ready for
faster and more decisive moves from monetary policy. Indeed, they
are beginning to demand them, even when they mean rising interest
rates. By avoiding the excesses which follow from rapid money
growth or inordinately weak money growth, such a policy would
eventually reduce the general level of interest rates, and markets are
beginning to recognize this.
It is interesting to note that although the money stock has moved
all over the waterfront since the targets were announced, the Federal
Reserve has generally reached its announced four-quarter goals since
they began being announced. Between the second quarter of 1975 and
the second quarter of this year, the four-quarter rates of M1 growth
haYe ranged between 4.6 percent and 6 percent. ,Ye estimate that the
growth :for the :four quarters ending this quarter will be 7.4 percent.
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We only have 2 weeks of data to go, so I am reasonably comfortable
with that number.
This will be the first time that the money stock has deviated substantially from the targets over a four-quarter period. It moved
around in between but the Fed has always reached that four-quarter
target.
This present deviation is troublesome. It is, however, the first time
that the Congress has had any grounds for complaint under the procedures set forth by the Federal Reserve and implicitly agreed to iby
the Congress. If the Congress feels that what happens to the money
stock within a four-quarter span has some near-term relevance to the
economy, it might wish to encourage the Federal Reserve to set more
specific targets for the short term publicly.
Longer term, one of the goals of monetary policy is to steadily
reduce the rate of inflation and long-term interest rates. Unlike the
quarterly targets and the congressional monetary policy review process, the primary impetus for this initiative has come from the Federal
Reserve itself rather than the Congress.
I urge the Congress to support it as well, as it is the only way to
return stability to financial markets, lower interest rate levels and
break the upward tilt to the inflation rate. Since the targets were first
announced on May 1, 1975, they have ranged from 5 to 7½ percent
for M1 then down to 4 to 6½ percent now. This net 1 percentage point
adjustment was the net result of 10 different settings of this target.
From the second quarter of 1975 to the latest statistical quarter, M1 has
grown at a 6.2 percent annual rate. Over the past-52 weeks, its average
level has grown by 7.5 percent. We need to make better progress than
this. We need to pull down the monetary growth rate more when the
economy is expanding. There will always be pressl}re to accelerate
money growth when the economy is doing less well.
I think we are dangerously close to building a high rate of inflation
,into our thinking and into our economy. Numerous Federal officials
'have said that a 6- to 7-percent rate of inflation may be an irreducible
minimum for the economy. I do not agree with this assessment, but it
indicates the length to which inflationary mentality has pervaded this
country.
With recent rapid growth in velocity likely to continue, 7½ percent
money growth no longer is as modest or tame as it might have appeared a few years ago. We are seeing 4 to 6 percent velocity growth as
a matter of course now. If velocity continues growing in the 4- to 6-percent range, which it can quite plausibly do, and we get the 5 percent
real growth optimistically forecast by the administration, 7½ percent
money growth if sustained would lead to 6 to 8 percent inflation. If real
growth fa]ls short of 5 percent, the inflation consequences would be
worse.
These are crude numbers but I think they give you the flavor that
if we keep on the path we are in now, we will be accelerating inflation, rather than pushing it down to the 5 to 5½ percent range which,
I think, is quite attainable in the near term.
To give up this deceleration and instead accelerate inflation would
do no one any good. It will not show up in .generally greater real
growth. Even the hopeful administration forecast does not foresee
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this. Maintaining money growth at the 11 percent rate of the last
quart~r or the 7½ rate of the las~ year_ would be a serious step backward m our efforts to squeeze the mflat10n pressure and mentality out
of our economy. We have made progress and will make 'more if monetary conditions are kept under control. Now is the time to begin
reining in money growth.
As recent monetary growth does not seem to have been completely
desired by the Federal Reserve, it is worthwhile considering how this
might be avoided in the future.
I think Governor Partee very eloquently in his own way explained
how monetary growth sort of slipped upward this year. One reason
is that the increases took place in the form of numerous specific bulges
traceable supposedly to specific nonrecurring events.
. You heard about the April bulge, the ,July bulge. Every bulge
m money has had a story, so it seemed.
We used to have stories about stocks. Now we have stories about
M 1 • There are several bulges due to a change in the mailing schedule
for social security checks, one due to the New York City blackout,
one supposedly to be due to variations in the Saudi Arabian fund transfer schedule. All of these plausibly seemed at the time like transitory
shocks which would soon be reversed. But they were not reversed.
As I think Governor Partee said, some of these will be unwound on
their own record. They have not all been reversed by any means, however. They have proved to be part of a new surge in the money
stock.
I think the Federal Reserve should try to get a better handle on
these underlying trends and not accept these stories about these specific
increases. I think the Fed could have had a better chance to see there
was an underlying surge in the money supply if it had paid more attention to the monetary base. This aggregate-currency plus bank reserves supports-the monetary aggregates. In July and August it was
providing fuel for the monetary expansion which took place and
which continues.
Accordingly, with this and the other recent difficulties of policy
in mind, I offer the following recommendations for improving the execution of monetary policy.
One: More attention should be paid to the monetary base as a
precursor of trends in the other monetary aggregates. The base seems
to be ignored in policymaking now. This should be changed to help
separate unusual blips in monetary data from developing underlying
trends.
Two: Season adjustment procedures for the money stock need to be
improved. When changes in seasonal factors appear and are known,
such as varied timing in the mailing of $7 billion of social security
checks, some method should be available to adjust the data. Seasonal
adjustment techniques also need to account for patterns from policy
changes differently from variations due to purely seasonal influences.
Three: The changes in short-term interest rates required to control
the monetary ·aggregates are not as detrimental to markets as you
might think. Markets now understand that the money supply cannot balloon indefinitely without showing up in higher inflation and
higher interest rates later. Sometimes markets become more upset by
stable rates than rising short rates.
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Give markets a chance. ·while some real-world discretion and caution always have a place in conducting monetary policy, it should not
be hamstrung by fears of excessive impacts on markets. Indeed, the
effects of delayed policy moves are generally worse than those of
prompt moves.
Thank you Mr. Chairman.
Chairman ~IITCHELL. Thank you for a provocative statement.
Let me make an a pology for the subcommittee members. "\Ve all serve
on -33 different subcommittees. Many of the members said they would
be back. I hope you understand that we begin at 10 with the regular
committee hearings. That accounts for the absences.
Professor Dewald?
STATEMENT OF WILLIAM G. DEWALD, PROFESSOR OF ECONOMICS,
OHIO STATE UNIVERSITY, AND EDITOR, OF "10URNAL OF MONEY,
CREDIT AND BANKING"
Professor DEWALD. I don't have a prepared statement. But I have
an article on economic forecasts for 1978 that is available for distribution to members of the subcommittee.
[The article referred to follows.]
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S-1
BULLETIN OF
BUSINESS RESEARCH
FIGURE 1
PRICE AND OUTPUT DETERMINATION
(Price
Level)
SUPPLY (High EmplO)'mtnt
Output)
STATISTICAL SUPPLEMENT
··I''·
Center for Business and Economic Research
fj'I ~
The Ohio State University
Volume LIi, Number 8 • Aupst 1977
DEMAND
The Trend of Business
Inflation and Unemployment-A Pro1nostic
Model for Fiscal Year 1978
Appraising the stance of economic policy and the outlook for the economy can be organized in basically different
ways.
The first and most commonly employed method builds
XF
x_,
X I Real Output)
The article proceeds to lay out a brief methodological
outline of the key variables and assumptions on which the
model is based. Then it looks at the evidence of current and
recent values of these variables and presents a forecast of
what the analysis suggests is ahead in the near term future.
a forecast from the bottom up, appraising performance in
detailed subsectors of the economy and linking them into
an aggregate. This is the method of the large model builders
such as those who created the Wharton, Chase Econometric, or Federal Reserve-MIT models; and variants of
this method are used by many professional business economists. Often such m'odels are thought of as Keynesian
because of their emphasis on the structure of the economy,
particularly with respect to spending components.
The second method uses a so-called "reduced form"
model which essentially builds a forecast from the top down,
focusing on the major determinants of total spending and
not much on its components. So long as the underlying
structure of the economy does not change, this method
can be employed very successfully and usually at far less
cost than the alternative. Such reduced form models are
often considered as monetarist models because of their
emphasis on money as a major factor influencing total
spending rather than any particular component of it. The
model of this article represents an attempt to use a variant
of the "St. Louis" monetarist model of the U.S. economy.1
Interestingly our reduced form mcxlel yields several results
that are broadly Keynesian, not narrowly monetarist-most
particularly that prices are very slow to adjust to major
economic shocks, that not only money but also government
spending significantly affect total spending, and further
that changes in spending in the short run are mainly
reflected in output and not in prices.
The key variable is demand pressure-the gap between
total demand and supply in the economy. Supply is
measured by "potential" or "high employment" output as
calculated by the President's Council of Economic Advisers
and used by the Federal Reserve Bank of St. Louis. High
employment output grows as a result of improved production techniques or increased numbers of productive
agents. Historically it has grown on the average by about
3 to 4 percent a year.
The demand for output can be above or below high
employment output. But there is a tend~ncy for demand to
be equated with supply by adjustment in prices. This is
demonstrated in stylized way in Figure 1 which shows
aggregate supply (high employment output) and aggregate demand as related to the price level. If the economy
were operating at price level P-1 and real output level
X-1 with aggregate demand in excess of aggregate supply,
the price level would tend to rise to P at which point
excess demand would be eliminated and supply and demand
would be the same. That is an ancient doctrine of economic
theory.
It is interesting to look at the historical record of demand
pressure2 and the inflation rate for the U.S. economy as
shown in Figure 2. The fact th~t calculated demand pres-
1 l.conall C. An<lersen and Keith M. Carlson, "A Monetari~t Mo<lcl
for Economic Stabilization,"' Ret•iew, Federal Reserve Bank of St. Louis,
April 1970, pp. 7-2'5. The key spending equation in the model i~ basetl
on Leonall C. Andersen and Jerry L. Jordon, "Monetary and Fi~cal Actions:
A Te,t uf The1r Relative Importance m E.:onumic Stabilization," Review,
Federal Reserve Bank of St. Louis, November 1968, pp. 11-24. A
ree~timation of the mrxlel appeare<l in Leonall C. Andersen and Keith M.
Carb,on, "St. Loui~ Model Revimed,'' lntrl'national Economic Rel'iew, Vol.
15, No. 2, June 1974, pp. 305-27.
2 Demand pressure is defined operationally as the quanerly change
in total spending (.6. Y) less the real output gap [high employment real
output (XFJ less actual real output last quarter (X-1)]. Rearranging this
~tatement from !"::.Y-(XF-X-1) to (l::!..Y+X-1)-XF, .6.Y+X-1
can be interpreted as the level of 1lemand for real output at the preceding
quarter\ price level; XF i~ the level of supply. Thus, Jeman1I (.6. Y
X-t)
les~ suppl)' (XF) i~ exce~s tlcman<l or demand pressure. The inflation rate
i~ the quarterly change in the GNP deAator at an annual rate.
(Continued on page S-2)
1977
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
The Model
+
BULLETIN OF BUSINESS RESEARCH
59
S-2
The Trend of Business
(Co,u,u,d f,om ,,,, S"J)
FIGURE 2
INFLATION RATE ANO DEMAND PRESSURE,
UNITED STATES, QUARTERLY,
sure has been negative on the average over these years presumably reflects a bias in the measure since if demand pressure had in fact been negative we would have had deflation,
not the inflation that was actually observed. One may infer
that the true level of high employment output grew less
than the CEA estimates. If in fact high employment real
output grew less than has been assumed since 1970, then
demand pressure would have been uniformly higher,
bending the demand pressure curve upward after 1970. But
even without such an adjustment, the statistical relationship
is apparent in Figure 2. Demand pressure as measured was
persistently increasing from 1961 through 1965 and remained high through 1968. This was reflected in accelerating
inflation. Demand pressure turned down in 1%9 through
1971. This was reflected in subsequently decelerating inflation until mid-1972. Except for 1973 1, demand pressure
as measured was negative throughout the 1970s. It increased
1956 1-1977 II
(Continued on page S-3)
Business Conditions in Ohio and the United States
UNITED STATES
OHIO
CHANG■ Fao•
CHANGI F'KoM
June
1977
ITEM
M-,
June
1977
from
M•>
1977
GENERAL BUSINESS
INCOMB
• TotalPeriaonal Income'· 13
Salaries A Wa&"es Income'•,.,
Nona&"riculturallncome1•1
Employee Earn.-Grou Wkly.: Mfl"t-"· 11
"
"
Conat.u.u
A&"r.Income (Ca,bMkt&"a.110,11
EMPLOYMENT A UNEMPLOYMENT
C)vilian Labor Force"
t·,
+
11,1,
Number
%
June
1977
from
June
1976
DollGn
DollGn
76.181
,,
7f>,6f>O
,,
286.52
377.75
281.05
379.71
4,85ft.8
4,5f>1.7
4,266.1
83
165
42.7
304.l
4,796.1
4,512.5
4,226.7
81
160
42.2
284.5
5.9
1'51-U
Thowand,
ThOU111ands
Th.ou.and.
Number
Thowo.nd,
Percent
Thowanda
Thowand.
Mil.Doi.
S,3
77.3
399.5
"'
terl)") 1•1
+
+
,,1
+
2
I
-
I
+
+
+
+
+
+
+"
+ 12
+ ~6
+ 13
+ •
+
+
+
+
+
+
+
I
2
3
5
17
2
-20
3:ti +
-19
~
219
1!
1911
Thow.Toou
1961!
Thou1. To,u
Thous. Tons
Dura e
oo a- ew
1,956
4,645
1,3~~
,,,,
rder.'J
CONSTRUCTION (Vah1e of Contraeta)
• Total !Sea.a. Adj.)D,22
ToteJ•.1:1
DISTRIBUTION
Total Retail Salea••"
Department Store Sales•• 1,
New Paesen&"er Cara Registered"·"'
New Trucks Registered•·'"
U1edCa"Re1"i1tered'
PRICES
i,41~
12
"
253
5.166
260
227
170
+
8
-
5
+ :l
+ ,'
6,952
40,384
Mil.Doi.
19.413
1.0~:
18,831
7,0ti
-
-I
+
I
+
+
Thou.a.Doi.
8
19'1
10
Bil.Dot.•••
Bil. Doi.•••
Bil. Do!.•,A
Dollar•
Dollar•
t./
Mil.Doi.
,,,,
+ 2'
+
+ 2
+ 2
+ 13
+ I
- 11
-
+
Thouaan<U
Thouao.nda
Th-nil.
Number
Thouaand,
Percent
Thouaand•
3
12
,,
Bil.Dal.•••
1911•
Thoua. Tona
Mil.KWH
Thou1.T01ta
Thou•. Ton•
Mil.Doi.
Mil.Dol.
Mil.Dal.•
2
IO
,,
,.
+.n
+"
+ .~9
+ 63
+ 2
+"
+648
+
+
+
+
+
+
+
+
+
+
10
2
IS
25
7
+1a1
+ll'.i2
+
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
'"
1.530
987
1.495
227.51
295.37
99,135
91,682
87,862
35
Mil.Do!.•
9
255
J,520
982
1,484
224.07
296.25
96,193
90,042
86,664
23
+
I
+
+
2
+ •
"
+
+
+
+
I
21
,,5
1.869
139
ll,384
138
12,201
-
63,180
7,530
220.26
262.40
58,.522
61,560
7,962
185.70
266.95
69,176
2114
15,417
5.945
6,409
317
1.5,932
5,660
3,047
7,225
59,233
59,247
+
+
+
+
I
±:
+
-
-"
+
!
+
+
3
+ •
+ •
n.a.
+
I
-
3
19
5
I
l
3
1~
1
5
I
+ :
+ :
2
12
+ II
+ II
+ II
+ 9
+n.a,•
3
3
3
+ •
-
,.
7
181
195
218
182
194
206
+
I
-
,,
+
3
2
3,l~f
,.,
311,1118 307,026
124.998 124,042
19'1-,'3::::10
1!19.~
110.7
1U1-U::::10
55.2
64.3
197/l::::IO
14.9
15.5
Psrceni
8.00
11.17
Mil.Doi.
Mil.Doi.
6
month•
1977
from
1976
+"
+ II
+ II
+ 12
+ 9
+
3
+
I
+
+ 1,3'
I
191
40.3
6,161
Mil.Dol.4
6.061
6.112
No.-471111. t,041,606 1.007,306
No.-U 8ls. 317,9~~ 305.3~~
I
.;'"\
'"'
2,9~~
3,063
15
June
1977
from
June
1976
%
40.7
7,453
,,
-37
Lut Year
----
C,
1961
1961
-,c-fo-di-eo-,.-,-,.-,;n-,h-,-,.-,,-,-,,-,-,-."-11-.-,"""",,~,-.,-,.-,.-.-,,-to-,,-ao-,.-,,-,.-,-,-.,-,-,"-,,-----iL
BULLETIN OF BUSINESS RESEARCH
1977
182
1917
1911
1917
BANKING AND FINANCE
June
1977
from
16,284
1911
• Coat of Livinl"'•
• Wholesale Commodity Prices••
Sensitivelndua.Commodities'•
• Bank Loans, Larll'e Banka-Tot11Ju
"
..
"
•• Bua. A Agrlc.ll
Stock Price lndex-400 Indust.~•
"
"
"
40Utils."
20Trans.~'
Yield. Corp. AAA Bonds$!
Lut
Month
M•>
Bil.lE~.NY•·•
Numbsr
+ ~o
+ 12
-
,,
,.
No.-S:tco11.
No.-27coa.
t.!~
+
4,6.%
2'2
227
157
6,875
42,299
1951-5~•
1951-5i•
19fJ1
llfli,
orlnde:i:
BuePer~d
-
"'
1977
6
+ "8
2,081
-76
206
1.gJ: _,,
299
""
+
179
"2
+ •
Residentla]Buildln&""·"'
Nonresidential Buildinll'•·n
Ut!Htiea and Non-Buildlnll' Con&t."•"'
M•>
';(
1,,'I
Mil.Dol.•,A
Mil.Dol.•,A
June
1977
months
1977
from
1976
½
I
Thaw.Dal.
19tJ1
1911
}'rod.'
LaatYear
1977
U11it
orlndez
Bo.••P•riod
• Bank Debltr, ll
Commercial Fallurea-Number1J
Commercial Failurea-Liabilitlea"
LifelnauunceSale1•
La,t
Month
2
.
+
10
+
2
-+
10
--
±!
+
-
2
+
7
n.a.
+ 21
+"
C 1'
+"
+ 4t
+"
+ II
+ 62
+ 10
+ 9
+ II
+ ~/
+
+
+
7
6
-
6
+ '
+"
+ 16
+
26
+
+
27
40
+
+
+
6
6
II
+
+
5
+
+ 29'
+ II
+ 12
+ 9
+ ~.4
..
I
+ '6
+
+ 21
-
6
6
2
-I
16
+
-
-----------AUGUST
60
The Trend of Business
though at a slower pace than in earlier recoveries in 1958,
1961, or 1971-72.
An inadequacy of this simple supply and demand
framework of Figure 1 is that it fails to incorporate inflationary expectations. One would be nonplused to explain
the persistence of continuing price increases in years like
1975 and 1976, even if at a slowed rate from earlier, when
demand pressure was in fact substantially negative. So
(Continu,d from,,.,, S-2)
substantially in 1972 and 1973, boosted a lot by import price
inflation. This was followed by accelerating inflation. Demand pressure as measured decreased substantially in 1974
and 1975; and this was followed by decelerating inftation
to about the 5 to 6 percent rate that exists today. Through
1977 II demand pressure in the current recovery has remained very weak absolutely. It increased in 1975 and 1976,
( Continu~d on pag~ S•4 J
Business Conditions in the 8 Largest OHIO CITIES
June
19'1'1
ITEM
May
19'1'1
June
19'1'1
from
June
19"16
June
19'1'1
6
mont
ll6
60
lt,C
•Manufaeturinl'
Trade, S.rv.• 6 Util,.
Con,trueUon
169
130
219
123
156
129
217
86
91
73
p'l~I~:
E,.~-.~~~t~2!"' Wkb',':
lllanufaeturins
Trade, S.n., 6
Con,truC"tion
89
72
4'1
1265.1'1263.48
"306.38303.98
"201.42204.36
"410.39364.79
UtiJ■•
"
RetailSale■ I
AutoTltle.l:
New Cara
Nnr Truck■
Retail Food Prlea"
• Bank 0.blbl
rcialFailure.11;
'
'
+
25
+ 5'1
+ g
+ 5
+ 46
+ '15
+ 25
+ 16
+ 21
+ 22
+ 20
+ 13
+ •
"
+ 35
T~•- ::~::
14.1
5.8
n.a.
.
N
87
109
70
+
192
1'17
-
16
+21
~1:
,,
+
31
+
14
+ •
+119
+114
+~26
28
128
n.a.
+n8
+134
+2~2
-
+ '
-23
Total•
Jfanulaeturinl'
Tract., s.n., .. uui..
Co11.1truetlon
103
p'lo~:=
•f;_7!~=.1•0I Utlbi.
Con■tructfon
Emp. 11:am.-Gros■ Wkly.f;
Alllnduatriea•
llanufaeturinl'
Trade, Sffv,. 6 Utlla.
Con,truetion
.
rlff111
Lt
rndu■• OWft Con,111np. 1
V¥:.Jol Bldl', Con1t.•:
e..ldentlal
Nonl'ftldentlal
Si.el Produetlon 11
Labor
Civil
Civil
Un
Un•mp
"
10,
81
123
56
203
155
257
123
200
1116
21i4
106
!
231.21 228.94
.,2116.02276.39
., 166.8' 167.16
9'317.76321.45
Retalls.Jw'
AutoTIU••:
New Cara
122
66
~!·
JII
,,,,,
No,
TAou. I
,,,,,
1111•
Th~.
No. "
Rate%
1977
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
6,384 6,025
1,2:!9 1,2~f.
488
53'
n.a,
b
n.a.
h
+
+
"
4
6
3
+ 20
+
+
19
~&
21
n.a,
n.a.
,,
+
+
-
21.6
5.0
8
13
-26
+
+
+
+
+
15
15
19
2
'1
+
349
n.a.
t,
+
6
n.a.
n.a.
"
188
242
1~2
169.4
158.4
ll.O
6.5
l
168,2
156.6
11.6
6.9
102
73
148
77
101
73
146
7'
11
18
8
2
lSI
146
262
166
1'1'1
141
269
162
11
14
9
4
314.71
362.22
23'1.71
386.28
302.89
344.22
232.76
390.78
3,931
6~3
3,728
6~3
296
284
8
+
1'1
+ 1131
16
+
,,
+ 31
+ 22
+ tt
8
+
+
9
+ 10
9
+ ,&
3
+
+
n.a.
+
b
6
"
+ 21
+ 14
+11as
+ 1 + 1
+ • -17
+ 3
-26
19'16
+ 1
+
+ '3 + •
-18
-1'
+
+
+
+
+
+
+
+
+
94
'16
114
'12
212
1'12
Z'l'li
1&1
182
161
232
Ui'l
241,86234.78
304.03288,84
164.H 166.2'1
393.68 386.86
6,632
1.006
198
396
+
+
+
+
+
+
99
406.3
3'14,7
30,6
7.6
401.6
373.'1
27.8
6.9
+
+
-
5
-
92
'18
110
63
+
+
8
5
11
16
3
19
+
8
+ 12
X
8
4
+
+
+20
+t,19
C
e
n.a.
n,a.
b
h
17
265
273
n.a.
n,a,
+
"
+
"
1
+ 3
-1'
92
76
110
64
1
e
+
+
+
9
I
1'1
6
14 12,42811,233
+ 25 1,0'16 1.103
+ 'J
200
200
+ 39
3'18
331
"
l
20
-16
6
+
+ '1
+
-11
+
l
l
4
9
+ 21
+ 14
36
4
+
+
+
10
+ 15
+ 14
+ 18
+ 4
4
+
9
9
9
9
6
+
b
4
n.a.
157
159
131
2'19
F,J
288
228
3!9
-
1..
2
39
-t2
236.1
220,0
16.1
6.8
233.6
218.4
16.2
6.6
2
4
-14
"
77
1<0
"'
126
96
161
UI
'162.6
'10'1.'1
H.9
6.0
743.,
'101.8
41.6
6.6
'J
16
4
+
+
+
+
n,-,••
+ 12
n.a.
+
97
'19
123
63
9'1
'19
123
'10
191
1'10
191
245
130
169
239
158
26'1.43264.16
311.6130'1.36
19'1.39191.89
393.60 414.U
e
2,163
h
260
e
2.262
2~2
241
n.a.
5
119
126
+
+
+
+
,o
34
1147
334
407
2'-'1
99
2'19
f.3'1
93
99
+
+
·+
2
4
-12
132,4
122.4
10.0
7.6
130.1
121,1
8.9
6.9
+
2
1977
Imm
19'16
"
+
+
+
+
-
+
%
-
.
111
38
3
~
:
18
20
21
2
6
+"
+"
+
It
+ •
12
l
21
Ii
+ 1,
13
'1
+ 2'1
+
+
+ 2
+ •
+ 1
+ 12
+ 18
+
7
+
+
+
+
21
12
7
17
n,a.
"
+ 91 +
+ 68 +
+186 +
+
3
-+ '1
-17
-
30
34
2'1
'1
+
1
-17
YOUNGSTOWN
+
n.a,
6
montba
+21
+
+
%
-
+
+
+
+
+
n.a.
n.a.
-
+
e
+
%
283.60 2'12.35
31'1.61309.69
232.30221.14
449.95 413.22
1
3
-21
1
+U'
-
210
1'1'2
258
225
181
Ii
1
8
TOLEDO
+
..
+174
+ 1
+
-30
4'1
-63
3
215
1'17
261
23'1
+ lli
+
IMii
+
+
+
+
,,
266.3
252,6
13.7
6.1
133
112
112
32
20
52
28
8
4
16
13
8
43
June
19'17
from
June
19'16
%
+
+
+
"
102
137
11
-
+
l
CHANOB FKo11
LASTYILU
CLEVELAND
n.a.
103
90
115
IOf.
15
+ h6
""
...,
19'1'1
lli
180
1'19
+ 19 + 12
154
148
+ 11 +
+ 18 223 225
+
2'1
+ 13 + 1 133 146
10 307.03 29'1.0li
+ 11 + 11345.42326.53
+ 15 +
'1 269.73 255.61
+ 4 +
+ 16 + 8 391.38421.'13
103
91
114
100
+
...
"
8
1
+ 15
+ 11
+ 9
277
2'10.3
256,3
lli.O
Ii.&
6,601
1,05'
198
Hli
+
25
4
47
18
18
+ 19
+ l'1
+ 7
June
6
mont
19'17
from
19'16
%
100
'1'1
126
'11
'/,,
n.a.
n.a.
23
19'1'1
from
n.a.
8
I
6
+bl&
:~g :~:::
16
49
-13
%
+ ..
b
+
24
366
lune
June
GAYTON
+ 18 +
+ 16 +
+ 19 +
+ 27 + u +
+
+ u +
+ 16 +
+ 7
+ It +
+
+ ll
1
+ '
-28
-
+
+
+
h
May
19'17
%
1
l?'1
10
+
-15
%
+
186
135
186
24.9
6.8
+
+
+
108
'10
h
COLUMBUS
Numbar Emp!o,ecP:
June
19'1'1
CINCINNATI
1117
169
241
129
262.88 263.69
l'1290.16291.64
13 206.'12 205.97
6 366.'12 371.43
4
e
1'11
13.6
5.7
239
93
86
+ 15
+
+
+
+
183
201
1:4
::::I + 2
6
monthB
19'1'1
from
19'16
%
%
+ •
+ 12
+ 1
n.a.
n.a.
June
19'1'1
from
June
19'16
CANTON
%
Total•
llanu.faeturinl'
Trad-. S.n., A Uttbi
ConatrucUon
May
19'1'1
19'1'1
from
19'16
AKRON
Number J:mployed1;
CHANGE Faox
LASTYBAII
CHANGE FROM.
LASTYBAS
CHANGII FRoM
LAST YEAR
+
" ++ "'•
+ 10
+
+
-
+
+
+
-
1
6
16
'1
24
15
44
7
1
+ 18
+ 11
+ 10
+ 10
+ ..
+ 20
13
+ 20 +
16
+ 26 +
+ 11
+ 4 + 10
+ 6 + 8
+ 17 +n.a.u
+ "'
+" •
+
+
+ 6
+ ..
+ 97
+ 82
n.a.
'1
92
+ H
+25'1
&
-
l
2
-28
+
.
+ 21
_,.
-
BULLETIN OF BUSINESS RESEARCH
61
S-4
The Trend of Business
(Contm ..,d /,om,,.,, S-3)
Figure 1 needs to be interpreted not only in a dynamic
way to reflect real growth in high employment output, but
also in an expectational way to reflect that prices can continue to rise or fall on the basis of inflationary expectations.
Accordingly, a point such as the intersection of supply and
demand in Figure I where the price level is P and output
XF must be interpreted as one where demand is increaliing
at the rate of growth of high employment output and
actual and expected inflation are equal. Changes in demand
pressure are considered to affect inflation rates only marginally beyond the built-in expected inflation rate. Th~s the
inflation rate in the short run is not solely a functmn of
demand pressure.
One aggregate supply factor that merits special mention
is import prices. Just as a reduction in the labor force or
the supply of any productive agent would reduce potential
output and increase the price level, so would an increase in
the cost of imports used in the productive process. It seems
clear that the oil import price boost in 1973-74 was precisely
of this kind, simultaneously jacking up prices and reducing
the supply of real output in the aggregate.
Spending
The next step is to discuss the factors that critically
affect aggregate demand over time. Three are enumerated:
.6.M -Changes in the quantity of money ( currency and
demand deposits held by the public).
6 EF -Changes in high employment federal government spending on goods and services.
6EX-Changes in exports.
Each has been found to be an important determinate of
changes in total spending ( LI Y) not only for the United
States3 but other countries too! The first two are measures
of monetary and fiscal policy to which the economy would
be expected to react. The third, exports, is also such a factor
but is determined by foreign demands for U.S. goods and
services which would reflect comparative prices inclusive
of shipping costs, tariffs, and exchange rates. In each case
the lags in the estimated effects of these variables on total
Multiple regression equation, third <legrcc: polrnomials for AM and
.6.EF, first degree pol)·nominal for .6.EX:
4
5
I
8. Yt
-0.oJ
Z: aJAM 1_J
Z: pjl\EF1_ 1 + Z: 'YJ.6.EXH
(--0.02)
i=0
i=0
i=0
3
ao
a1
a:i
113
a4
=
+
= 2.75 ( 3.37)
= 0.57 ( 0.80)
= 0.93 ( 1.99)
= 1.32 ( l.95)
= --0.77 (-0.90)
Z:o. 1 := 4.81 ( 4.76)
+
Po
Pt
fJ2
f:Js
fJ-4.
fJri
=
=
0.25
0.37
0.45
0.42
0.25
--0.IO
1.63
=
( 1.03)
')'o
0.87 ( 2.69)
( 1.95)
'Yt := -0.64 (-2.00)
( 2.58) Z:'YJ := 0.23 (-0.58)
( 2.33)
( 1.27)
(-0.41)
( 4.03)
Z:fJ1
Sample period: 1956 I - 1977 U
Test statistics:
0.72
Coefficient of determination (R 2)
Standard error of estimate
(SE)
8.20
(DW)
1.80
Durbin-Watsonstatistic
T-values are recorded in parentheses Oeside estimated regression coefficients,
4 As reported in the authors' "International Prices and Exports in
'St. Louis' Models of Canada, France, Germany, Italy, the Unit«! Kingdom,
and the United States," presented at the Konstanzer Seminar on Monetary
Theory and Policy, June 1977.
=
=
=
BULLETIN OF BUSINESS RESEARCH
97-814 0 • 77 • 5
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Federal Reserve Bank of St. Louis
spending are quite short, about a year to a year and a half
for money and government spending but only 6 months
for exports. Indeed exports are estimated to have only a
transitory effect on U.S. spending. The estimated spending
changes captured the actual speed-up in spending in 1972-73,
the collapse in 1974-75, and recovery in 1975-76. Accelerating
and decelerating monetary growth was the principal explanatory factor; but government spending was also a
significant factor.
What the future holds for the effect of these variables is
discussed in the concluding section of this article. But with
high and perhaps accelerating growth in money and government spending, the prognosis in a nutshell is expansionary
for the near term future but not quite enough to keep
pace with growth in potential output.
Inflation
The next step is to discuss the basic factors that affect
inflation. The statistical relationship suggested from the
discussion of Figure 1 is that inflation is a function of
demand pressure which would increase the actual relative
to the anticipated inflation rate. Also a factor would be the
import inflation rate which in itself would contribute to
inflation unless offset by domestic price deflation. Thus, the
factors that critically affect the inflation rate are the following:
D-demand pressure defined as LIY - (XF-X-,) .
p-observed domestic inflation rates.
W-observed import inflation rates.
These variables are used to calculate an anticipated in~
Ration rate by taking current and past values of the
variables available in some particular quarter, say 1977 II,
and using estimated weights to calculate the expe~ed effects
of the explanatory variables on inflation.r. The weights were
estimated by relating actual inflation rates to pa~t ~alues. of
demand pressure, import inflation, and domestic 1nflauon
n Multiple regression equation, third llegree polynominals:
3
16
6
+ 2: aJ(O/XF)t.p + Z: wjl''lt•J-1 Z: "'JWt-J-1
j:=0
i=0
i=0
+
l'>t :::;- 0.00575
(5.56)
ao := 0.068 ( 1.54)
0.1 := -0.052 (--0.80)
Cl2 :::;- 0.123 ( }.99)
Cl.S
-0.002 (-0.04)
:;al
=
=
0.138 ( 5.73)
w- 0 := -0.129 (-1.16)
'lrl := -0.050 (-0.73)
11":!
0,011 ( 0,28)
ra
0.055 ( 2.07)
g:~~~ ~
::
WO
"'t
W-J
wa
t;~~ ::
0.048
0.018
0.012
0.020
(
(
(
(
3.74)
"2.23)
J.54)
3.43)
~:~~! ~ ~:!~~
"'6
w-7
w-11
0.l IO ( 3.60) "'6
0.021 ( 1.29)
0.1IO ( 3.64) z:w 1
0.184 ( 4.37)
0,104 ( 3.54)
1r9
0.094 ( 3.23)
'11"10 := 0.083 ( 2.78)
11"11
0,072 ( 2.36)
'lrl:! := 0.064 ( 2.12)
11"13
0.061 ( 2.14)
... 1-1 := 0.066 ( 2.23)
w-1:;
0.079 ( 1.97)
'll't6= 0.104 ( 1.59)
Z:w1
1.022 ( 7.73)
Sample Period: 1956 I· 1977 II
Test statistics:
Coefficient of determination (R 2 ) := 0.91
Standard error of estimate
(SE)
0.0031
Durbin-Watson statistic
(DW)
1.98
T-values are recorded in parentheses beside estimated regression coefficents.
=
=
=
=
=
=
AUGUST
62
rates. The idea is that inflationary expectations if derived
rationally would use available and relevant information
efficiently in projecting the future course of prices. The
results indicated that demand pressure had a cyclical effect
on measured anticipated prices and also that import prices
importantly contributed to inflation not only after the burst
of inflation in the 1970s, but before. And most importantly,
there was a finding of an extremely long lag in the adjustment of the inflation rate to shocks from whatever source.
Output
It is important to note that this niodel of the U.S.
economy is "recursive" which means that changes in spending affect inflation but inflation does not affect total spending. An interesting implication of this is that increases in
the inflation rate, say as the result of an increase in import
prices, will, in the short run, have the effect of reducing
real output, at least until other prices adjust relatively.
Indeed it is precisely this characteristic of the model that
made it superior to its large structural model counterparts
in estimating the effect of oil import prices on U.S. real
output in 1974 and 1975. In other words, the model is structured so that short run increases in the inflation rate are
reflected in declines in real output given the level of spending. Essentially the model specifies the dollar value of
spending as insensitive to prices, being determined solely
by exports and the stance of monetary and fiscal policy.
Since policy is assumed to be relatively autonomous, the
economy through price adjustment must react to policy
rather than the other way around. Because the model makes
prices the chief adjusting variable and, as it turns out, price
adjustments appear to evolve so slowly, one gets the result
that autonomous changes in spending or in prices from
whatever source will in the short run mainly be reflected
in output and only in the long run in prices.
FIGURE 3
CHANGES IN ACTUAL AND ESTIMATED REAL
OUTPUT UNITED STATES, QUARTERLY,
1956 1-1977 II,
(1972 Basel
FIGURE 4
ACTUAL AND ESTIMATED UNEMPLOYMENT RATE,
UNITED STATES, QUARTERLY, 1956 1-1977 II
AND FORECAST 1977 111-1978 II
Output estimates are made by the following procedure.
Anticipated inflation and its components are translated
into dollar terms by multiplying by lagged real output.
Then the output estimate is derived from a definition. By
definition the dollar amount of change in spending ( 6 Y)
consists of a part due to real output change ( 6X) and a
part due to inflation ( 6P). Thus,
6Y- 6X+ 6P or 6X- 6Y-6P.
This identity permits one to estimate real output changes
indirectly from the estimates of spending change and the
GNP change due to inflation. Unlike the large structural
models that directly estimate real output, this model estimates spending and inflation directly and real output only
indirectly. Figure 3 shows actual and estimated changes in
real output. All told about half of the quarterly changes in
real output were explained by the model which translates
into an error of well under 1 percent of the levd of real
output. Though the estimates tracked actual output quite
well over ordinary expansion or contraction quarters, they
were uniformly too high at cyclical troughs in 1958, 1960,
1970, and especially in 1975.
Figure 4 shows the actual and estimated unemployment
rate. It is estimated on the basis of a so-called "Okun's Law"
relationship named after Brookings Institution economist,
Arthur Okun, the Chairman of the Council of Economic
Advisers under President Johnson, who publicized it. The
unemployment rate (U) is related to the estimated percentage real output gap (C) and past values of the gap.
is equal to the difference between the high employment real
output (XF) and estimated real output (X) divided by
XF. 6 The relationship fits the U.S. data very well even
though there is reason to suspect that such factors as the
altered structure of the U.S. labor force and unemployment
e
Multiple regression equation, a<lu~te<l for serial correlation:
Ut
3.93 + 0.089
0.168 Gt-t
0.086 Gt-2
(29.05)
(1.63)
(2.51)
(2.60)
(6' is the ~timated value of G.)
Sample Period! 1956 I - 1977 II
Test statistics:
Coefficient of de1ermina11on
(R 2 )
0.96
Stanllanl error of estimate
(SE)
0.27
Durbin-Watson statistic
(OW)
1.62
First onler senal corrclation coefficient
(p)
0.689
T-value~ are recorded in parentheses below regression coefficients.
(Continued on page S-6)
tl
=
et+
+
=
=
=
=
1977
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Federal Reserve Bank of St. Louis
BULLETIN OF BUSINESS RESEARCH
63
S-1
The Trend of Business
(Continued from page S-5)
compensation have substantially increased the expected average rate of unemployment in the U.S. economy in the last
decade. The unemployment relation shows that unemployment in the U.S. economy is very sensitive over the business
cycle with each 1 percent decline in the real output gap
being reflected in a 034 percent decline in the unemployment percentage.
Forecasts
The model discussed to this point was estimated for
data through 1977 II, Forecasts are the most tenuous but
perhaps the most important part of the analysis. Most economists are savvy enough to make forecasts only in the
privacy of their own clients' offices, but not all, as we are
about to demonstrate.
The assumptions on which the forecasts are based are
the following:
• The structure of the economy remains the same as
for the sample period 1956 1-1977 II.
• Import prices increase at about 4 percent and exports
increase about 10 percent by mid-year 1978, an assumption based on expected declining softness in foreign economies.
• High employment output expands at about 3.6 percent.
• High employment federal government spending expands at 13 percent in fiscal year 1978, about what the
administration has budgeted.
• Money expands at 6½ percent-the upper bound of
the growth announced by Chairman Arthur Burns
to the House Banking Committee at the end of July.
Table 1 records our forecasts based on these assumptions
as quantified in Table 2. The forecasts are definitely less
optimistic than many others that have been made public.
The inflation rate is forecast to remain at about the current level, rising in the fourth quarter but then declining
gradually in the remainder of the fiscal year. The model
calculates about a 7 percent inflation rate for fiscal 1978.
GNP growth is forecast at a nearly 10 percent annual
rate with some slackening in increases in the last half of
1977, but then a speed-up again in the first half of 197R,
as more expansionary policies, particularly fiscal policy
works through the economy. Forecast slackening in the
last half of 1977 is the result of a comparatively nonexpansionary stance of monetary and fiscal policy in most of fiscal
year 1977, as recorded in Table 2, which according to the
model affects spending with a lag. Also an important explanatory factor is the comparatively high rate of import
price inflation recorded in 1976 III and 1977 I which also
affects the economy with a lag. Finally the very weak export showing during the winter of 1976/77 did not help the
situation any. Thus, though the stance of both monetary
and fiscal policy is projected as being expansionary for the
long run, the economy of our model is largely bound by
past events with only limited opportunity for current policy
to influence current economic performance. As a corollary
BULLETIN OF BUSINESS RESEARCH
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Federal Reserve Bank of St. Louis
TABLE 1
QUARTERLY GNP FORECASTS BASED ON 6½
PERCENT MONEY GROWTH AND 13 PERCENT
HIGH EMPLOYMENT GOVERNMENT
SPENDING GROWTH,
1977 111-1978 II
Actual
1977
Forecast
1977
1978
---ii- "i1JIV
Indicator
·-1--n-
Billion1 of Ct1rrent Dollars
GNP Change, Total
58.2
Due to Past an<l Projected Changes in:
Money
High Employment
Government Spending
Exports an<l Other Factors
43
42
50
49
25
24
28
24
17
I
17
1
21
l
23
2
B1llion1 of Con1lant ( 1972) Dollars
20.6
37.6
Real GNP Change
GNP Change Due to Inflation, Total
Due: to:
Built-in Inflation
Import Prices
Demand Pressure:
5
37
5
37
II
39
10
38
38
38
39
39
16
15
14
14
-17 -16 -14 -15
Perant
GNP Deflator Annual Rate of Change
(1972 Base)
Real Output Gap
Unemployment Rate
6.62
10.02
7.0
5.1
10.5
7.5
7.5
l0.9
7.5
7.1
l0.9
7.6
6.7
11.0
7.7
there is a risk that attempts to improve current performance in a hurry would only worsen the future situation.
The most disheartening part of the forecast involves real
output and the unemployment rate. Since real output potential is assumed to grow at a 3.6 percent annual rate, unless demand grows as fast there would be an associated
increase in excess capacity and unemployment. That is what
the model predicts: a gradual build-up in the real output
gap from 10 percent in 1977 II to 11 percent in 1978 II,
and correspondingly an increase in the unemployment rate
from 7.0 percent in 1977 II to 7.7 percent in 1978 II. The
model does not forecast a recession technically because
real output growth is not predicted to decline, but it docs
forecast a marked pause in the expansion.
TABLE 2
QUARTERLY CHANGES IN EXPLANATORY
VARIABLES, ACTUAL, FISCAL YEAR 1977,
AND PROJECTED, FISCAL YEAR 1978
Projected Change
FY 1978
Actual Change
FY 1977
Variable
Billion1 of C11rrent Dollars
6M (Change in
3,1
Money)
6,EF (Change in High
Emplorment
Government Spending) 12.3
6EX (Change in
Export~
6.0
Ci.XF (Change m High
Employment Real
Output)
13.1
,.o
3.3
6.7
5.1
5.2
5.2
5.4
9.7
4,0
10.7
16.2
14.9
14.6
9.1
4.9
4.3
4.5
4.5
0.1
1.9
Billion1 of Con1tant ( 197Z) Dollar1
4.7
12.7
12.8
12.9
13.0
13.1
13.3
13.4
3.9
3.8
Ptrcent
W (Change in Import
Deflator)
17.2
1.7
15.9
8.5
3.7
4.2
AUGUST
64
S-7
Conclusions
What is such a forecast worth? Probably what you've
paid for it in reading through che article. Making a forecast
is a very chancy business. A lot could go wrong.
First, reduced form models such as employed in making
the forecast have been criticized by exponents of structural
models as being very apt to yield biased estimates. Not
everyone agrees; but the critics may well be right.
Second, the specification assumes that variables such as
money, government spending, exports, import prices, and
potential output are autonomous, i.e., not influenced in the
short run by the pace of economic activity. This could also
bias the results.
Third, we've taken monetary and fiscal policy makers
more or less at their word in terms of the stance of policy
in the current fiscal year. If money growth and government
spending growth turn out to he much different than we
have assumed the results could he very different. For example, if the monetary growth rate is set at the 4 percent
minimum of the Federal Reserve 4-6½ percent targeted
range, the model forecasts virtually no real growth compared with 2½ percent real growth if monetary growth is
6½ percent.
Fourth, in addition to monetary and fiscal policy assumptions, we've had to make assumptions about exports
and import prices. If other economies speed up their expansions, export growth could have at least a temporary
expansionary inAuence on the U.S. economy. Similarly if
by some good fortune import price inAation were eliminated, real output would get a substantial boost.
Fifth, and perhaps most unnerving to the reader, we
are very suspicious about a key coefficient of the model.
It is the estimated extremely small and slow effect of demand pressure on prices. It is our belief-but this requires
further testing-that the CEA potential output series is
overstated, particularly for the 1970s. One implication is
that demand pressure has in fact not been so negative but
perhaps even positive in the current expansion. Another
implication is that demand pressure appropriately measured
would have a stronger effect on price level adjustments than
indicated by our estimates. A third implication is that slow
real economic growth in the current expansion is not so
much a reAection of built-in inflation and inadequate aggregate demand but rather is a reAection of supply factors:
higher costs of key raw materials, slowed productivity
growth, a higher natural rate of unemployment because of
demographic factors as well as higher minimum wage
and government transfer payment disincentives to work
and so on.
Let the buyer beware! But for what it is worth, our
model yields a very pessimistic forecast of the course of the
economy over the current fiscal year.
To conclude, the analysis suggests that in the remainder
of the calendar year 1977 little if any real growth is expected but that real growth will pick up in the first half of
1978, the same pattern as was observed in fiscal year 1977.
The model and forecasts based on it offer no ready suggestions for alternative policies to those that appear to be
1977
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Federal Reserve Bank of St. Louis
in the works. Speeding monetary growth or government
spending could likely increase real output and cut the unemployment rate in the short run but only at the cost of a
higher inflation rate later. The interpretation that we put
on the situation is that the economy is still paying for mismanagement and bad luck in 1972 and 1973 which set the
stage for a long lasting inflation from which it apparently
takes a very long time to be extricated.
-William G. Dewald
Professor of Economics, The Ohio State University
-Maurice N. Marchan
Assistant Professor of Economics, Kenyon College
Financial support from the U.S. Department of Labor
under Contract #J9K60029 is acknowledged by the authors.
Ohio Retail Sales Trends
June Sales of Ohio Retailers
the previous month, but were
in May, both before and after
were 10 percent ahead of June
did not move upward from
1 percent lower than sales
seasonal adjustment. Sales
last year.
In the First Half of 1977, Ohio retail sales averaged
9 percent above first-half 1976 levels.
By Kind of Business, first-half sales were ahead of last
year in most of the retail lines covered by the OSU Indexes.
Those retailers with the largest increases included drug
stores ( +20 percent), lumber-building materials dealers
(+17 percent), motor vehicle dealers (+16 percent), and
he:1ting-plumbing and electrical supply stores ( + 13 percent). First-half declines, experienced by 7 kinds of business,
were less than 10 percent.
-Linda L. Morris
INDEXES OF OHIO RETAIL SALES
INDEX (1907-59=)00)
CHANG■
Unadju1ted
Seas.
June
May
June
1977
1977
1977
~
KIND OF
BUSINESS
Ad).
f---,---June
1977
from
May
J977d
Total Retail Stores'· "
Grocery Stor""'
Other Food Stores
General Stores (With Food I
272
303
153
Department Stores
Other General Merchandise
201
201
25'
2'7
"o
m
Family Clothing Stores
109
Women's Ready-to-Weal' Stores 128
Shoe Stores
113
210
109
1<0
1<0
112
Furniture Stores
Household Appl.-TV-Rdio Strs.
127
Men's Clothing-Furns. Stores
Home Furnishings Stores
Motor Vehicle Dealers
Other Automotive
Filling Stations
127
189
159
452
168
300
26'
"'
"'
"'
"'
206
130
+ 4
+ 4
- 2
+13
+10
-- 8
+ 6
+n
-- 7
+
-
+ 2
+ 2
-3
-6
l
-1
x
3
7
-1!<
+
+
+
l
I!
+~
182
162
+15
+16
395
1'7
292
+22
+16
34:1
-ta
+23
+12
272
26'
+36
+11
+15
+12
+17
+
+
+
-2
439
163
+
+
2
x
170
117
196
240
217
4
138
+
~
! -
+
9
-20
+16
+
-
3
2
9
+ 8
7
+13
+10
n.a.
171
189
164
117
167
228
150
180
170
195
171
108
-10
3
291
400
317
-10
-15
+20
+3
+
+8
163
+
+
-1
State Liquor Store!!
For 1ource and footnoteoi, -
+
1"
109
171
246
Eating and Drinking Places
Drug Storts
Jewelry Stores
Florists
Fuel Dealers
Hay-Feed, Farm & Grdn. Strs.
1976
%
+10
+ 9
-1
- 4
Hardware Stores
1976
..!'11
Lumber-Bldg. Mat!s. Dealers
322
Paint, Glau & Wallpa)ler Strs. 194
Heat,-Plumb. & Elee. Sup. Strs. 197
Farm Equipment Dealers
June
6
1977 months
from
1977
June from
+'
+
_,
X
1
3
+11
--2
n.a.
3
3
n.a.
pap S-6.
BULLETIN OF BUSINESS RESEARCH
65
S-8
Number Employed, Payrolls, and Man-Hours in Ohio Industry
....
,
NUMBER EMPLOYED·,
INDUSTRIAL GROUP
June
1977
. .,
81
98
97
82
Bakery
79
Mbcellaneou.
82
Lumber Product.II (37)
Furnltun
lllleellaneoua
102
91
113
97
83
76
83
Fora-ins■
Supplln
Hdwe.
"" "
" "
106 103
"" "
119
"
60
60
71
91
71
90
67
.
... ."
""
.
"
"
87
98
117
Pa~ni1:t;t:1:::~.
68
60
Mbcell■neou
69
Rubber Producta ( 49 i
81
67
Tire■ ■nd Tube■
Mi■cell■neou■
Cl■:,, ■nd Gl■SII
Brlek ■ndTile
Stone,
01-
VltreoW1 A Semi-vit.
Ml■cell■neoWI
Producta (77!
Chin ■
A Pottery
Te:xtiln128)
Men'■ Clotbins
Mbc.Jl■ neoWI
Vehteln(48)
Auto.and P■rb
Can, Electric and Steam
Mi■cell■neou■
80
" "
"
61
""
""
"
"
80
93
."
"
" .
"'
"'. "'.
'". .
"'
82
70
R■ ilwa:,
Mbcellaneou■
Manufaetul'in,r (49)
Total Trade, SerYlc11, and Utllltie■" (622)
Se"ice (178)
Trade, Reta.II and Wholesale (345)
Tr■n ■pol'tation A Public Utllltie■ ( 104)
Coutr■etlon (320)
Mine■ and Qa■ rrin (SO)
1977
fmm
Ma,
1977
86
83
82
82
71
70
ll7
107
127
.
%
%
••
'
' +'
+ l +
+
+
+ I +
+ l2 + I
+
I
+
+ 12 + 10
+ 16 + 16
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
-
I
4
I
l
2
+"
+185
+ 16
+
+
+
+
+
+"
+ 10
-
+
+
+
+
+
26
+
+
+
+
+
l
I
:
1977
+
+
+
+
+
+
.
•
,
' '"
179
167
175
183
171
-10'
+
+ '
+ •
+
+
+
+
+
+
+
+
19
10
I
•
2
36
''
164
l
-12
+
+
+
+ 10
+ l
+ 16
+
1'6
1'3
172
149
170
7
2
3
189
160
109 109
89
89
118 118
186
179
232
216
188
163
218
186
201
137
l
143
+
9
uo
136
164
-10
+ 16
+ 26
,
205
163
187
160
l3l
,
161
168 163
119 116
207 166
167
103
99
141
187
172
"" "
103
86
+ 3
+
+ 118
+
+
+
+
+
201
IOI
190
228
' "'
"' "'"
! 210 "'
"'
"'
• "'
3
June
June
1977
fmm
1977 months
1977
fmm
June Imm
1976
1976
Ma,
1977
%
+
+
+
+
2
+
+
+
+
+
+
3
+21
+
+
+
1977
. .,
...• ,. "''""'
•
' +.
.
• • '"
...'"
' + • '" '".
+.
'"
' +
"'
+ . + "' "'
3
+
+
June
100
126
126
197
206
177
176
281
162
.
CHANGII
11H7=100)
June
6
1977 months
1977
fmm
June fmm
1976
1976
June
1977
." .
." "
Total• (2.052)•
All ll•n•faetarlns.. (1,080)
CheP1.icab (66)
Food Pnduct.t (83)
PAYROLLS'
INNX
CHANG■
(1967=100)
%
••
%
+
+"
+ 17
+
+ 2 +"
+ 2 + 6
+ l + 7
+
+
+ 28
+"
+ 20 + 30
+ 3 +
+ 11
+
+
+ 167
+
+
6
+ 6
+
+ ..
+
+ 166
+
+
+
+ 10
+ 23
+
+ 10
+
+
+ 30
+ 12
+
'
..
'
+
+
±. !'
+
+
+
+
+243
+ 31
+ 11
+"
+ 2
+ 10
+ 27
8
+
+
+
+
+ 20
+ I
+
+
+
+
+
+
+
'
6•
+
+ 13
+ 17
+"
+ 21'
+
+ 17'
+ 12
•
+
+
l
l
+
+ 10
+"
+11
+
+
+
+
+
+
+
+
+
%
+ II
+"
+ 7
+ 10
+
+ 11
+ 21
+"
+
16
+ 10
+"
-17
+
+ 26
+ 26
+"
+"
+"
I
+"
3
+ 8
l
+
'
+"
I
+ 11
.. +21
.•
+"
+ 42
+
22
+
+"
+
+
+ 18
'
9
-21
+
+ 21'
+ 22
+ 21
+ 11
+
+
+
June
1977
""
• ++ '
,." ' ++ '
+ 11'
" + +
+ 17
1976
1977
..
.
." ."
"
"" .
"
. ".
" "
.
." ."
" "
""" .
.
90
87
93
7B
76
76
75
83
109
73
93
71
83
61
81
61
67
66
87
92
88
76
92
82
81
121
76
68
76
78
78
130
70
77
50
99
89
60
88
61
90
72
72
71
71
83
101
107
134
61
92
.
61
.
+
+
+
:
3
3
+
+
6
1977
fmm
1976
%
+
+
+
+
'
I
+
+
+ 116
+
l
+
+ 3
'
I
-11
- l
+ 3
+ 6
-13
+ 10
+
+
+
+
+
+
+
+
+
+
.
..
+ •' + '
.• + •'
+
+ 10I
'l
+ 21 + 10a
+
+
I
-+ 6' --
+
+
+
+
+
3
+ ..
+
+
+
+
+182
+ 18
+ 16
+ 26
+ 10
I
+
-+" -+ 3
+
+
+
+u
_,.
-19
+
+
+
+
+21
+ l
+
+ 8I
+
+
-
l
17
3
I
_...
%
%
+
+
+ 2
+ 2
+ I
+ 3
+ 13
." "'" .
,. "'
108
5
June
1977
fmm
June
•
' "'
,.
+"
June
1977
fmm
1977
76
8
CHANCII
. .,
78
+
+ 13'
+
MAN.HOURS"
INOU
(1967::::100)
X
+"
-11
+ 12
+
+
12
28
+ 10
+ 2
+
+ I
•'
6
+"
-21
-10
+ 8
+
+"
+ I
•
•
+ 8I
+
+ ..
+
+
+
+
+ 17' +
X
'
Indexes of number employed ■nd of p■yl'Olb are hued on the employment of 490.001 pe!'l!On■ (Pl'Oduetlon workers in manufacturinir and mininir, construetlon wol'ken in contn.ct constl'uction. and nonsupervisory employees in other cateiroriea) in 2,052 firms; Indexes of m■n-houn, on the employment of
480,098 production workera ■nd nonsupervisory employees in 1,990 fl.rms. Fi1rures in parenthe■ ea ■how number of firms repol'tlng employment and payrolls.
In some CBSell fewer firms report man-houn, Data do not Include a1rricultm'1!, eovernment, education, or public Institutions. For sounes •nd footnotes, below.
·
FOOTNOTES FOR BULLETIN TABLES AND CHARTS
!Change in number of failures: •Figures in parentheses sho3/ number
of firms reporting this month; ,u.current data not available; bComparablc data not available; conly percentage of change ava1\able: dA<ljustetl
for seasonal change; 1Acljusted for number of working days; IFour wttks
average; 11 Annual rate; l'Preliminary; rRevised; ~Series rcvisal; "'Weighte<l:
"Less than 0.5 percent; YMore than 1,000 percent mcrease.
Primary Sor,r,u:
Computed from: 1 Ccn1er for Business and Economic Research multiple
rcgrns.ion model.
Computed from original data collcctctl by the Center for Business and
Economic Research from: ~Ohio retailers; 3 County Clerks of Courts:
4 Local Power and Light Companies.
Computed by 1he Center for Business and Economic Research from
cla1a supplied by: 5 Boan.l of Governors of the Federal Reserve System:
BULLETIN OF BUSINESS RESEARCH
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Federal Reserve Bank of St. Louis
6 L1fe Insurance Agency Management Association; 7 Division of Research
and Statistics of the Ohio Bureau of Employment Services, collected in
.:ooperation with the Bureau of Labor Statistics, U.S. Department of Labor;
SfeJeral Power Commission; 9 F. W, Dodge Company; 10Dun & Bradstreet. Inc.
Other data M>urces: 11 Fcdcral Reserve Board; 12 Dun & Bradstreet, Inc,;
1 au.S. Department of Commerce; 14 Division of Research and Statistics of
the Ohio Bureau of Employmcm Services; uu.s. Department of Labor;
16 Dcpartment of Agricultural Economics, O.S.U.; 17 U.S. Department of
.\gnculturc: 18 Industry Wttk: 19 American Iron and Steel Institute; 20 U.S.
Department of Interior; 21 National Machine Tool Builders• Association;
~~F. W. Dodge Company; 23 R. L. Polk & Co.; 24 Standard & Poor's Cor•
porataon.
Note: In the Ohio-U.S. table, page S-2, <lual source notes on a single lifte
of the table stub refer first to Ohio data, sttond to U.S. data.
AUGUST
66
Professor DEWALD. I would have more confidence in these forecasts
if I were Governor Partee and could do something about one of the
key elements on which the forecasts depend; namely, the rate of
monetary growth.
I must admit to this group that I am somewhat of an eclectic. I
believe that fiscal policy as well as monetary policy are important
in affecting spending, prices, output, and unemployment. I think
Congressmen have to be eclectic, too.
In my view, the key economic problem that we face is the result of
bad economic policy a long time ago. In a sense we have got an awful
lot of 'built-in inflation in the economy and it's very difficult and costly
for us to be extricated from it. In a word, the kind of economic policies,
painful as they may be, to solve this problem involve a slowdown in
the rate of growth of Government spending, a reduction in taxes, tariff
cuts, and a reduction in the rate of monetary growth. That's the elixir.
It may be a painful medicine.
Over the course of the business cycle, this last business cycle that we
are living through, we had high hopes with congressional intervention
through House Congressional Resolution 133 and its aftermath that
the procyclical variation in money growth that had been observed in
every other business cycle in recorded history, that that pattern might
not be observed this time. In 1974, in 1975-particularly after the
resolution-we hope that the rate of monetary growth would be
higher during the depths of the recession and the early stages of the
recovery than afterward.
Yet the fact is, the rate of uionetary growth was lower in 1974-75
than it has been recently. In the last 1½ years, the rate of monetary
growth was higher, for example, than it was in the preceding 1½ years.
So even though the Federal Reserve is to be commended for what it
aims at, there is some criticism on the basis of its failure to hit targets
or guides, or whatever it is one calls what the Federal Reserve is aiming at in terms of monetary growth.
A word about the model that I referred to. It's a forecasting model
based on a version of the Federal Reserve of St. Louis monetarist
model of the U.S. economy. However, it is not 100-percent monetarist
because it finds a significant effect of Government spending and exports on total spending in the economy. It also finds a significant effect
of import prices on the level of prices. It is a monetarist model, however, in the sense that it finds that changes in money have the most
important effects on total spending and prices in the long run. A
dollar increase in money is estimated to cause a $4 or $5 increase in
the total amount of GNP over the long pull. The long run indeed comes
farily quickly on the basis of these estimates-in the period of about
1½ years.
That model is a 'bit of an embarrassment to me now, since the Federal
Reserve has behaved in the period since the end of June in a way that
surely was not expected on the basis of its announced target monetary
growth rates.
Nevertheless, the model does suggest on the basis of the forces that
were at work in the economy through midyear-and these forces have
lagged effects on spending and prices-that there would be a marked
slowdown in the rate of economic growth. That is accountable to the
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Federal Reserve Bank of St. Louis
67
fact that the rate of monetary growth this past year has been highly
variable. It was relatively slow particularly in the last quarter of 1976
and the first quarter of 1977.
Those changes in money have a lagged effect on the economy. Also
Government spending, inexplicably to some of us has increased moderately during the course of the last year. And exports have slowed,
as was reported in yesterday's newspaper. Furthermore, in the last
fiscal year we experienced several quarters of very high increases in
import prices.
In any case, the main characteristic of the economy that is causing
the present difficulty and the main characteristic of the model on
which this forecast depends is its very slow reaction in terms· of price
adjustments. Prices adjust very slowly in the U.S. economy. And
there is prasently a lot of built-in inflation in the economy. It is fouling
up the tax system and wage system, and profits and interest rates.
In other words, the whole economy.
Unhappily instead of Government policy pursuing an even course,
it has really been on a roller coaster, which has added additional uncertainties to the economic situation. Given that we had a recession in
1974-75, there was a good opportunity for economic policy to 'be put
on a steady course. Surely the congressional budgetary and monetary
oversight responsibilities established then can be interpreted to have
aimed at this; but instead, monetary growth has been up and down
on a short-term basis, and indeed a long-term basis too. It's been well
off target, as Dr. Gibson explained, for protracted periods of time.
Fiscal policy has been restrained to date at least on the spending
side and considerable fiscal drag has been introduced as a consequence
of inflation and increases in income. This has also been a factor that
may have damped the current expansion.
We can't entirely fault policymakers in 1977. They inherited an
incredible problem. ,vhat we need in this situation, I believe, is a
realistic approach that doesn't promise or expect instant results. Policy
should be set on a steadier noninflationary course. And the economy
should be restructured to permit individuals and business to serve
themselves and their country more efficiently. I think that means tax
cuts and tariff cuts which are both long overdue.
In any case, we have had policies in the past that seem likely to have
set the stage for a recession m the next [ear or two. As far as monetary
policy is concerned, with the rates o monetary growth well above
targets, if the Federal Reserve brings these rates back to target the last
6 months this deceleration in the rate of monetary growth will be
associated with a subsequent recession if it follows patterns that have
been observed earlier in history.
Thus there is a dilemma that is faced because of bad policies in the
past. Any efforts that ·are taken now to avoid the oncoming recession
may well accelerate the already high rate of inflation and make the
next recession all the worse and make it all the more difficult for us
to extricate ourselves from an even higher rate of inflation.
There may be a lesson for us from the Swiss, who, accordin~ to yesterday's Wall Street Journal, in 1974 and 1975 fought inflation with
such fervor that they created a recession, even worse than experienced
in other countries. But they got the inflation rate down to under 2 per-
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Federal Reserve Bank of St. Louis
68
cent a year, and now they have the basis for sustaining growth. I
think that kind of policy 1s what we have to aim at in the long run.
Thank you.
Chairman MITCHELL. Thank you very much.
Prdfessor Laidler.
STATEMENT OF PROF. DAVID LAIDLER, DEPARTMENT OF ECONOMICS, THE UNIVERSITY OF WESTERN ONTARIO, LONDON,
CANADA
Professor LAIDLER. Mr. Chairman, I am even less prepared with a
formal statement than my two colleagues, but I think you will be relieved to know that I am not going to disagree with them at all, despite
the fact that we haven't colluded in advance.
I thought that my most useful contribution as an opening statement
might be to go down the questions which are listed on pages 3 and 4 of
your own opening statement and comment on them one at a time.
The first question is: Why are short-term interest rates rising at
the same time that money growth is accelerating?
It seems to me that there is an interaction of at least three factors
here. The first is that the real economy is expanding; and at this stage
of an expansion, you would expect that real expansion to be pulling
interest rates up with it.
Second, I see no reason to disagree with Governor Partee's argument
that a contributing factor here has been the fact that the Fed, somewhU;t belatedly, has tried to get hold of the monetary growth rate
agam.
Finally, I would like to echo what Dr. Gibson has said about the
role of inflation expectations here. It does seem to me that, when the
money supply has been growing above track for 6 months, you would
expect participants in markets to notice this, and to build it into their
expectations. In these circumstances it does indeed take a greater rise
in interest rates to bring the money supply back on track than otherwise would have been necessary had action been taken earlier.
I would submit one bit of extra evidence here that hasn't been
brought out yet, but which I think is consistent with the view that
rising inflation expectations have something to do with the recent behavior of interest rates. That is the performance of the U.S. dollar
in foreign exchange markets recently; I think that its weakness reflects growing worries about the future course of U.S. inflation; and
I would be surprised if this was not related, to some extent at least,
to the recent behavior of the money supply.
Now the second question is: Would still faster money growth contain upward pressure on interest rates 1
I think implicit in that question is a dangerous fallacy which has a
long history in economies, that we don't have to go into here. The
fallacy is that if monetary policy is easy, interest rates are going to
fall and if monetary policy is tight, interest rates are going to rise.
The difficulty is that, built into interest rates, as we have already
said, are expectations about inflation, and the above-mentioned fallacious view about the effect of monetary policy on interest rates ignores this.
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Federal Reserve Bank of St. Louis
69
The brief answer to your question is that still faster money growth
might contain upward pressure on interest rates for a matter of
months, but that ultimately it would contribute not to downward
pressure but to upward pressure on interest rates.
In this context, I might just refer to the quotation in your opening
statement taken from the evidence of Professor Fair to the Joint Economic Committee. I am not familiar with the detai]s of the model
upon which he based his predictions. However I find it surprising that
he could apparently talk about a stable bill rate, which is a nominal
interest rate, contributing to the achievement of full employment by a
target date like 1980, without any reference to the effect of maintaining that bill rate on the rate of inflation and without any reference to
the implications of inflation for the feasibility of maintainng the bill
rate stable.
If it is the case that the monetary growth rate that goes along with
the kind of policy that Dr. Fair has been recommending is 10 or 11
percent, then I would-simply on the basis of the past behavior of
the U.S. economy-be arguing that an inflation rate of 9 or 10 percent, and an accelerating inflation rate of 9 or 10 'percent at tha.twould accompany the full employment and balanced budget of 1980. I
do not see how a bill rate of 4 percent or so would be compatible with
such an inflation rate. Hence I find Professor Fair's views, as reported,
both difficult to accept, and very worrying as a basis for policy.
The third question is: ,vhat are the risks of 9 percent or even faster
money growth, for example 10 to 11 percent per annum~
I am concerned that those risks are real indeed. The reason for my
concern is that, if I understand Governor Partee's evidence correctly,
it indicates that the Fed is still trying to kill two birds with one stone
with its monetary policy. It's trying to control monetary aggregates,
but at the same time it appears to be taking a view as to what are
appropriate levels for interest rates. And I think it's clear that you
can go for one yariable or the other, but you cannot go for both variables with your monetary policy. If you do, you inevitably fall between two stools.
My interpretation of the last 6 months is that the Fed has indeed
fallen between those two stools and hence has achieved neither of its
incompatible targets. If the Fed continues to try to maintain a chosen
level of interest rates, there is a grave risk that monetary growth will
accelerate faster.
Perhaps I should just say a word as to why I would rather look at a
monetary aggregate than look at interest rates as a prope,r target .for
monetary policy. In the best of a11 possible wor1ds, if economists understood everything, it wouldn't really matter which we looked at. We
could announce a time path for the money supply and tell you what
that implied for interest rates. We could announce a time path for
interest rates and tell you what that implied for the money supply.
However we are jm,t not that wise.
As I read it, the work that has been done over the last 20 years on
the U.S. economy has told us a lot more about the nature of the relationship between the behavior of the money supply and that of prices
and output than it has about the link between interest rates and those
same variables. I don't think we know how to interpret the behavior
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Federal Reserve Bank of St. Louis
70
of interest rates. And precisely because we don't know how to interpret
the behavior of interest rates, they are a very bad variable to be looking at in designing short-term monetary policy.
I don't think I am saying anything here that is inconsistent with
Governor Partee's evidence. He said that he thought the recent behavior of the money supply was a short-term bubble, and that the
behavior of interest rates was associated with this short-term bubble.
But he wasn't really sure, and seemed to agree that if it wasn't a short~
term bubble, action would have to be taken. It's precisely because you
can't be sure what is going on when you are looking at interest rates
that I would prefer monetary policy to be geared much more explicitly
to achieving targets for the monetary aggregates than it currently is.
One could then let the market sort out an appropriate time path for
interest rates given all the factors other than the behavior of the money
supply that impinge upon their determination.
Question 4 is: Would the recovery abort if M 1 growth was squeezed
so as to be under 6½ percent for 1977 as a whole?
My arithmetic suggests that this would mean that, for the balance
of the year, the monetary growth rate would have to go to some.where
between 3 and 4 percent, having been up to 9 percent. That is an enormous turnaround. Though I don't think that any of us can be definite
in answering a question like this one, I would say that the risks o:f
aborting the recovery would be substantial if such a turnaround in
monetary policy was set in motion now.
That then brings me to question 5, which asks, might not the best
solution now be to start anew?
I think that implicit in my answer to question 4 is the conclusion that
it would be a good idea to start anew. But I give that answer with considerable trepidation becam:-e one of the great advantages in setting
explicit targets when making economic poficy is gained only when targets are followed through on. The public gets confidence in the stability of monetary policy if targets are set and are then seen to be adhered
to. I don't think it's a light matte,r to be recommending abandoning a
target which has been publioly set. It i.s very much a second best solution in a bad situation.
Finally, what track would I design i I suppose I would be arguing
that since we are now starting from a 9-, 9½-percent rate o:f expansion
of the money supply, a target over the next 12 months of, shall we say,
6 to ·7% percent might be an appropriate one.
I would hope that when this new track was adopted, there would be
a public announcement that interest rA.tes were, no longer going to be a
secondary target of policy. It would then be cilear to the public that
along with the revised targets there was a revised policy regime. That
might give the public a little more confidence that :future targets would
be adhered to and wouldn't go the way of previous targets.
That's all I have to say by way of general introduction, Mr. Chairman.
Chairman Mrrcirnu,. Thank you very much.
Professor Laidler, you indicated that there should be some kind of
announcement made that interest rates would no longer be a secondary target. I assume that that just makes good sense. For the consumer,
one thing that is most visible, has a large impact, and is meaningful,
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Federal Reserve Bank of St. Louis
71
happens to be the interest rate. I just don't see how we shift away from
interest rates as the i;::econdary target with that sort of attitude existing
in the business world and among the general consuming public. How
do you do that?
Professor LAIDLER. I think that it's really up to academic economists to make it plainer to the public than we have in the past that the
choice re,allv is not between stable interest rates and monet.arv fluctuations on the one hand and stable money and fluctuations in interest
rates on the other. Stability in interest rates over the next few months
will be bought at the price of much more insbtbility in the future, because the monetary fluctuations that you are going to have to put up
with now to stabilize interest rates are eventuaUy going to come
through and cause instability in interest rates. It is the old, old problem of persuading the public that they can buy long-term stability in
interest rates only at the cost of some short-term instability. If we wero
starting off :from a stable monetary situation, this probiem wouldn't
arise, but we are starting from a position that is way out of equilibrium,
and it cannot be avoided.
Chairman MITCHELL. I think what I at least inferred from Governor Partee's testimony is: While it is good and desirable to establish
targets, given the operation of the real economic world, they cannot be
adhered to. I believe that is essentially what I heard him state. Is that
your opinion?
Professor LAIDLER. I think the. difference here perhaps is one of
emphasis. I would not want to come down and say let the money supply grow in nominal terms at an annual rate of 5 percent per annum,
month by month, week by week. day by day no matter what happened.
I can conceive of situations in which some real exogenous shock to the
economy might make it desirable to rethink a monetary target and
perhaps give it up in the short term. I would cite as an example of this
the OPEC oil price increase. The OPEC oil price increase represented
a. substantial real shock to the economy, and one could argue that rigid
adherence to a monetary rule while that was going on was not the best
short-term option, though I think that that was nevertheless a viable
policy option.
Even so, I can well understand arguments that some of the impact
of that kind of shock should he absorbed by relaxing the monetary expansion rate in an upward direction for maybe 12 months, taking a
little more inflation and a little less unemployment as a consequence of
the shock. However, my own reading of the evidence is that that kind
of shock is really rather a rare event. I wouldn't advocate announcing
monetary targets year by year while simultaneously assuming that
every 6 months the world is going to change so that as a matter of
course the announced target is going to be given up. I would urge that
in every instance the onus of proof must be put upon those who want
to give up a preannounced monetary target rather than being upon
those who want to adhere to it.
Chairman MITCHELL. This then goes back to Dr. Gibson's emphasis
on the monetary base and our paying more attention to it. Dr. Gibson¥
Dr. Grnsox. I just wanted to comment on Governor Partee's statement. It is my interpretation of what he said, and my interpretation
of what the Fed has done, their position is not that the monetary
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targets once set should not be adhered to. Rather, I think their position
is the monetary targets once set should not be carved in granite, but
they should be free to revise them and then change them over time. In
£act, they haven't done very much of this.
Chairman MITCHELL. You see, that is what we did. We established
a great deal of flexibility in the range, acting upon their request. Still,
they have not adhered to them.
Dr. GIBSON. That is right. I did not interpret Governor Partee as
saying that the Fed takes the targets loosely. Rather I thought he said
he did not want to commit what the Federal Reserve would do because
conditions might change and the Fed might have to change the target
range, not that the Fed was going to ignore the target range.
Chairman MITCHELL. Let me get one more question. If we are talking about definitive, critical target ranges for M1 and M 2, what would
be the feasibility, going back to your theory of looking at the entire
economic base, of establishing definitive ranges across all of the M
spectrum i Is that workable 1 Could we begin to do it in terms of
M1 and M21
Dr. GIBSON. I personally would not recommend that.
Chairman MITCHELL. It sounds like a planned economy, does it not~
Dr. GrnsoN. You would have to know a lot more than we know. I
mean, just on a theoretical ground. Chairman Burns, a year or two
ago, set forth eight different M's. Now there are more candidates because we have new aggregates we did not have back then. You have to
know an awful lot about the interrelationship between the demand for
one of those aggregates and the other. I do not really know that it is
very fruitful in that when all is said and done, you need to kind o:f
hitch your wagon to one or the other. That is, you have to have faith in
a specific measure when various measures are moving in different
directions.
The other thing is, from the standpoint of monetary policy, if you
have 10 aggregates, you will typically hit the target on over five of
them at any one point in time, anytime. If your main concern is really
with M1, it is irrelevant to have somebody come in and say, "Well, I
hit M 4 through M10 , and only M1 is out of line." If you think M1 is the
most important variable :for the economy, as I do--and as I think the
Federal Reserve really does-then how we are hitting those ranges is
not so important as what we are doing on M1.
Chairman MITCHELL. Do either of you gentlemen want to comment
on thati
Professor LAIDLER. Could I add a supplementary comment i I agree
with everything Dr. Gibson has said. I think the difficulty of setting
targets for more than one monetary aggregate is compounded at the
moment by the way in which rates of return on components of the
various aggregates are either administered or set. A zero rate of interest on demand deposits, :for example and, the operation of regulation
Q on the return on less liquid deposits, make it much more difficult to
:forecast in the short run the way in which the aggregates will grow
relative to one another than it need be.
Chairman MITCHELL. Professor Dewald i
Professor DEWAW. There is an article in the most recent issue of
the Journal of ~oney,_ Credit and Banking by Roger Wurd that
looked at the period pr10r to the last recession. He :found M1 was a
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more effective measure of tightening monetary policy in that period
than M 2 , Ma, et cetera. There are those who have favored M2 or some
broader definition of money because it is possible for them to look at
data that go back further in history, but there is something comforting
in a way about M 1 • It does represent the principal transactions
medium. That kind of money is something that remains pretty much
the same in terms of its function in the economy.
Even though there are a lot of factors that can affect the demand
for M 1 , I think it is a reasonable target that the Fed and the Congress
have selected. It is interestin~ that in Germany, the monetary authorities have gone in the other direction and picked monetary targets that
are more narrowly defined than M 1 • In Germany the monetary target
in terms of which their monetary growth rates are announced is the
monetary base.
In any event, I think M 1 in the United States is probably the major
variable that should be looked at.
Chairman MITCHELL. Thank you. Mr. Barnard 1
Mr. BARNARD. Mr. Chairman, I apologize that I had to leave for a
short period of time.
Chairman MITCHELL. I did it for you. [Laughter.]
Mr. BARNARD. I hope that the questions I have will not be repetitious,
but if they should be, please feel free to stop me.
The public seems to hold the Fed responsible for monetary policy.
But should we not consider the factors outside of what the Fed controls that come. into play 1 I think Professor Dewald addressed some
of these conditions we are experiencing today: the export imbalance;
the fiscal policies; Government spending. Is there not some way of
coordinating the activities of other responsible players with those of
the Fed1
Professor DEWALD. "Well, I would hope so. I believe that the Federal
Reserve cannot be faulted for all of the ills that the economy experienced in recent years. Surely the four-fold increase in oil prices is
something that is not attributable to the Federal Reserve. Fiscal policy
over the course of the years has also tended to be destabilizing, just as
monetary policy has been.
We cannot really blame the Federal Reserve for inflations that may
be induced by huge Government deficits such as we have experienced
in war time, including the most recent war. Nevertheless, the Federal
Reserve is perhaps in a unique position with respect to economic
policy. It is very difficult for Congress to get tooled up to change tax
laws or to change Government spending. In fact, Congress can get
tooled up to change Government spending and for some reason these
d~ys the bureaucrats cannot figure out how to spend it. Maybe that
will change.
In any event, monetary policy is in a unique position with respect
to being able to make decisions and take actions quickly that can
affect the economy with a lag as estimated in a matter of only 1 year
or 1½ years. So monetary policy is in a position where it can offset
some of the problems that may have been introduced by disturbances
that have come from elsewhere.
Mr. BARNARD. What facilities do other countries use to monitor and
control monetary policy-for example, Switzerland i
97-814 0 - 77 - 6
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Professor DEWALD. Switzerland emphasizes monetary policy to the
extent that nothing else matters. It is very difficult for any kind of
fiscal action to be taken in Switzerland. It is a confederation. To
change basic fiscal policy would require something like an election.
They do have, however, a central bank, the Swiss National Bank. Central banks have the power to buy and sell assets and thus affect the
monetary base and the money supply. The Swiss have been willing
over the years to fight inflation more effectively and more vigorously
than other countries have. In any event, it is a country that emphasizes
monetary policy for more than anything else. They also, by the way,
are a country that have very low tariffs and consequently they have a
situation where the economy can operate quite efficiently on the basis
of taking advanta.ge of comparative advantage in international trade.
Mr. BARNA~. Dr. Gibson, did you want to respond to that i
Dr. GmsoN. It is true the Federal Reserve's hfe is complicated. It
does have the tools to carry out its responsibilities and it has been
given a number of responsibilities by the Congress to help in the Congressional function of coining money and regulating the value thereof.
So I think the Federal Reserve ought to be looked to to exercise those
responsibilities. It is somewhat like your situation as an elected official.
As a Congressman, you are in part responsible for the well-being of
your constituents on, say, economic grounds. There is an awful lot of
things that happen outside of your control: The OPEC price increase,
farm price increases, everything.
You do have some tools at your command to offset those and mollify
the damage. In the end you are held accountable by those who elected
you and who expect you to use your tools.
Mr. BARNARD. The reason I asked that question is because I am a new
Member of Congress, but I am very much interested in this subject, and
I try to come to as many of these hearings as possible.
In the early part of the year, you see, they were accusing the Fed of
overreacting 2 years ago, and consequently, not enhancing the recovery
sufficiently.
Now we are turning back around and saying, "Well, they let this
bubble develop. Now we have a monetary growth of 10 percent."
So I said-you know, I am sympathetic with these people. They are
damned if they don't, damned if they do.
How quickly should they react j Monthly, weekly, daily¥ That is
what is troublmg me now.
Dr. GmsoN. The Federal Reserve has had a tendency over time t.o
have a procyclical effect on the economy.
Mr. BARNARD. Can I interrupt you on that point¥ They accused the
Fed, when they put in the economic stimulus some years ago, that they
counterbalanced it immediately. As a result, they didn't get the effect.
Dr. GIBSON. I do not agree with that interpretation. I do remember
that. Anyway, you asked how quickly the Federal Reserve should respond. That is a very tough question. That gets into this whole issue
that has been lurking here: how do you identify an underlying trend in
money growth versus a 1-week blip or a 2-week blip j The Federal Reserve has been saying for a long time that you cannot expect the Federal
Reserve to respond to these weekly things. This is true, although in
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August and September, the weekly numbers got so bad they did start
responding on a weekly basis.
I think you need to watch the monetary aggregates and you also
need to watch the monetary base. If you see the monetary base, which
is sort of a leader of these other moves, moving up rapidly, and if you
see everything falling into place, I think you start responding very
promptly. If you see moves that appear to be aberrations not confirmed by movement of the base, then I would wait awhile. I would
wait perhaps a month or two before responding.
I think you need to look at what the foundation of the growth is,
plus how sustained and how permanent the short-term fluctuations in
the aggregates appear.
Professor DEWALD. Could I comment on that 1 I did empirical work
in early years related to this subject. The conclusion drawn from this
is that the Federal Reserve could directly control money rather than
use the indirect method that is currently employed and has been
throughout history. What the Federal Reserve does is to pick a Federal funds rate target for a short period of time. That is what the
buying a:nd selling of securities by the Federal Reserve Open Market
desk aims at; not at a particular monetary growth. That interest rate
target is manipulated by the Federal Open Market Committee in order
to achieve a particular target monetary growth.
Now an alternative-and it is something very simple-would be for
the Federal Reserve to look at a target growth in money, or the monetary base, or something like it that is in dollar terms; and then aim at
that and not at an interest rate. They could pick a quantity of Government securities to buy or sell that would, on the basis of their best estimates of the demand for money on that particular day or that particular week, pump money into the system by Open Market operations;
and then essentially they could let the banking system adapt to that.
"\Ve have observed in foreign exchange markets~10w willing private
entrepreneurs are to absorb shocks that hit that market from a variety
of sources. We have not had enormous day-to-day or minute-to-minute
fluctuations in foreign exchange rates. "\Vhy 1 Because there is a market
mechanism that tends to stabilize those rates, just as in stock or commodity markets.
The same thing could operate in money markets if the Federal Reserve would pump in the amount of base money on the basis of which
they would expect to achieve the target level of monetary growth and
let the short-term interest rate variations be absorbed by the market.
We have got fine institutions that can accomplish that. There is
really no reason why the Federal Reserve has to take the responsibility
of acting as a shock absorber with respect to interest rates. Let the
market do it. Let the Federal Reserve aim at monetary growth and
let these short-term interest rate variations be worked out in the
market.
Professor LAIDLER. Could I just make one comment, Congressman, on
your very first question i
I would like to associate myself with everything Professor Dewald
said just now about the choice of monetary instruments. I think that
comes back to what I was saying earlier about the Fed trying simul-
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taneously to hit interest rate. and monetary aggregate targets and
missing both.
You asked about the role of the .Federal Reserve System in the formation of economic policy. I think it is clear that there are many legitimate targets of economic policy : income distribution; the balance between the public and the private sector; the balance within the public
sector between the Federal Government and the State Governments.
There are a whole host of questions that the Federal Reserve has nothing directly to do wit'h. However decisions taken about those other
aspects of economic policy ultimately come down to questions of dollars and cents; and unless the value of those dollars and cents is pre<lictable, the outcome of those decisions is not going to be what is
intended. That is what makes the role of the Federal Reserve System,
which does have the power and the special responsibility to influence
the value of those dollars and cents, so central to the behavior of the
economy. If they mess it up, everything goes wrong-. If they would
only provide the background of stability against which the other arms
of Government could take these decisions, then it would be possible
to get to grips with all those other important economic poJicy problems.
Mr. BARNARD. I have no further questions.
Chairman MITCHELL. This is somewhat difficult for me to do. I know
something about the personality of the economist. Nonetheless I am
going to ask unanimous consent that an article by Milton Friedman
be inserted into the record at this time.
I do so with reluctance because I know that economists vary in terms
of their approaches. I am not at all sure at any given time with which
school of economic thought I am dealing. So just give me my unanimous consent and let me get that in the record.
Mr. BARNARD. I not only give it to you, I endorse it.
[The article referred to follows:]
[From New&week magazine, October S, 1977]
WHY INFLATION PERSISTS
(By Milton Friedman)
Nearly three years ago, I wrote in this space: "Four times in the past fifteen
years we have started on a cure for inflation. Three times we have abandoned the
cure before it had time to complete its task-in 1968, 1967, 1971. Each time, the
result has been a higher plateau of inflation, producing a new attempt at a cure.
Will we make the same mistake the fourth time in 1975? Or this time, will we
liave the courage and the wisdom and the patience to see the cure through?"
(NEWSWEEK, Nov. 4, 1974.)
ABANDONING THE CURE
As of today, the answer is that we have made the same mistake a fourth time.
Once again, we have paid the cost of a recession to stem inflation, and, once again,
we are in the process of throwing away .the prize. From a high of more than 12 percent in 1974 (from December 1973 to December 1974) inflation fell to less than 5
]ler cent (December 1975 to December 1976). It has now risen sharply, may tem11orarily recede as we work through the bulge produced by the special problem
of the hard winter, but then, I- fear, will resume its upward march, not to the
"modest" 6 percent the Administration is forecasting but to at least several percentage points higher and possibly to double digits again by 1978 or 1979.
There is one and only one basic cause of inflation : too high a rate of growth in
the quantity of money-too much money chasing the available supply of goods
and services. These days, that cause is produced in Washington, proximately, by
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the Federal Reserve System, which determines what happens to the quantity of
money; ultimately, by the political and other pressures impinging on the system,
of which the most important are the pressures to create money in order to pay
for exploding Federal spending and in order to promote the goal of "full employment." All other alleged causes of inflation-trade union intransigence, greedy
business corporations, spendthrift consumers, bad crops, harsh winters, OPEC
t•artels and so on-are either consequences of inflation, or excuses by ,vashington or sources of temporary blips of inflation.
There is one and only one basic cure for inflation : showing monetary growth.
But that cure is easier to state than to put into effect: witness our repeated
abandonment of the cure. The Fed is supposedly independent. But, as Dooley said
of the Supreme Court, "It follows the election returns." Its behavior reminds me
of nothing so much as the remark attributed to a U.S. Army officer in Vietnam,
"We destroyed the village in order to save it." Similarly, tile 1/'ed refrains from
using its independence because it is afraid of losing it.
Listen to Chairman Ar.thur F. Burns in testimony to the House of Representatives (July 29, 1977) :
"The trend of growth in monetary aggregates, I regret to say, is still too rapid.
Even though the Federal Reserve has steadily sought during the past two years
to achieve lower ranges for monetary expansion, the evolution of its projections
has been extremely gradual; indeed, at the pace we have been moving [note:
with respect to projeotiom, not behavior] it would require perhaps a decade to
reach rates of growth consistent with price stability. I must report, moreover
that despite the gradual reduction of projected growth ranges for the aggregates
during the past two years, no meaningful reduction has as yet occurred in actual
growth rates."
Meaning: promises have been in the right direction but too modest; performance has been in the wrong direction.
THE PERFORMANCE OF THE FED
The following documents Chairman Burns' description of performance :
the high rates of monetary growth from 1971 to early 1973 fostered the inflation that peaked in 1974. The sharply lower monetary-growth rates from 1973 to
1975 produced the serious recession of 1974-75 and the subsequent tapering off of
inflation. The sharp rise in early 1975 sparked the recovery ; the slowdown in
late 1975 produced the economic pause in the second half of 1976 that played such
a prominent role in the Ford-Carter election battle. Since then, monetary-growth
has been rising, not falling, and is now about back where it was in 1972.
Inflation will not be stopped by words, only by actions. At the moment, we have
the worst of two worlds. Nominal independence of the Federal Reserve without
its effective exercise permits Congress and the President to evade responsibility
for the creation of money to finance large government deficits. The power of
Congress to legislate and of the Presid-ent to approve such deficits without
explicit responsibility for the resulting monetary growth gives the Federal
Reserve an excuse for its inflationary behavior.
Again, let me quote Chairman Burns, this time from a speech on Aug. 13, 1977,
proclaiming "The Importance of an Independent Central Bank" :
"Theoretically, the Federal Reserve could thwart the non-monetary pressures
that are tending to drive costs and prices higher by proving substantially less
monetary growth than would be needed to to accommodate these pressures fully.
In practice, such a course would be fraught with major difficulty and consider•
able risk. Every time our government acts to enlarge the flow of benefits to one
group or another the assumption is implicit that the means of financing will be
available. A similar tacit assumption is embodied in every pricing decision, wage
bargain, or escalator arrangement that is made by private parties or government. The fact that such actions may in combination be wholly incompatible with
moderate monetary expansion is seldom considered by those who initiate them."
FISH OB CUT BAIT
It matters little whether the Federal Reserve is unable or unwilling to exerC'ise its independence in deeds as well as words. In either case, let us be done with
the fiction that "independence" is somehow or other a bastion against inflation.
Let us put the responsibility for the rate of monetary growth-and therewith for
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the subsequent rate of inflation-squarely and openly on the Administration and
Congress. Instead of simply requiring the Federal Reserve to report its "projections" or "targets" for monetary growth, let the Congress require the Fed to
achAeve specified rates of monetary growth (or specified levels of the quantity of
money) within specified ranges of tolerance. That would combine responsibility
and power. It would also enable the ordinary citizen to know whom to hold accountable for inflation.
Chairman MITCHELL. Gentlemen, let me say, you hear the phrasesthey almost become hackneyed phrases-about provocative testimony.
Indeed, it has been _provoca~ive. I ":ould really like to dig deeper in
terms of how we might begm to shift our approach and look at the
monetary base as the target, as is being done in some other countries.
Your testimony has been tremendously stimulating and tremendously
helpful.
Thank you very much for appearing.
[Whereupon, at 11 :05 a.m., the hearing was adjourned, subject to
the further call of the Chair.]
[The following briefing papers with attached exhibits were submitted by the subcommittee staff for inclusion:]
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B R I E F I NG P A P E RS
FOR
MO NE T A R Y P O L I C Y
0 V t R S I GHT HE A R I NGS
SUBCuMMITTEE
U1i
D0i1ESTIC MONETARY POLICY
OF THE
COMMITTEE ON BANKING, FINANCE, &URBAN AFFAIRS
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SEPTEMBER 27, 1977
PREPARED BY STAFF, SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
80
EXHIBIT I.
STORY.
Ml is shown in billion-$. So is the target range.
It was converted to$ levels by multiplying observed Ml in bHilion-$ each
quarter by the Federal Reserve's percentage growth targets and using the result
to show target levels four quarters later.
After entering the target range in March 1976 at its lowest end, Ml
crawled along the bottom until last fall.
In October, Ml was increased to
the middle of the range and kept there through March.
In April, Ml growth
increased at an annual rate of almost 20 percent and hit the top of the target.
In July, growth again approached 20 percent per year and now Ml burst through
the top of the range.
In mid-September Ml stood at $331.6 billion, putting
it $4-5 billion above the top of the target.
The monetary policies that were followed from early 1975 to October
1976, and which laid the foundation for recovery together with reduced inflation, have ended.
Recent rapid money growth places the economy's stability
in jeopardy.
The situation that is developing is reminiscent of a few years ago
when rapid Ml growth from early 1971 to mid-1973 fueled the inflation which
began in 1973, and which in turn, contributed to the 1974-1975 recession.
The rapid Ml growth since last winter, if long contintued, will surely
recreate the 1973-1975 inflation-recession cycle.
But it will be a tricky
business reducing Ml growth back into the target range. Decelerations nearly
always s,low economic growth for a time, but if we don't decelerate Ml growth
now, we face the danger of accelerating inflation and bringing a deep recession
later on.
The options would appear to be (a) to decelerate quickly and risk a
short but sharp economic slowdown, or (b) to decelerate gradually and risk
extra inflation with the risks which in turn would carry for production and
employment in two or three years, a deeper and longer recession.
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340 ...,...._ _ _ _ _.....,.._ _ _ _ _ _ _ _.,,,ex..H.,.l-=-B"-'IT'-=l------------~-------r340
M-1 MONEY SUPPLY CSA)
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82
EXHIBIT 2, STORY,
This graph shows the percentage change from
a year ago of three money supply measures, Ml, M2, and M3.
Ml is currency plus demand deposits.
M2 is M~ plus time deposits excluding CD's
M3 is M2 plus nonbank thrift deposits
Roughly speaking, the growths of the three M's move up
and down together.
Thus, it would not appear to matter very
much which of the M's is monitored in measuring the thrust of
monetary policy.
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EXHIBIT
MONEY
2
YE AR T O YE AR
P E R C E NT C HANGE
STOCK,
14.0
M3
12.0
,- ~
10.0
z
/
✓ -.J
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I
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8.0
Ml
6.0
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-t----.-----,--.-~.--.--,-~,-----.-,--r--r--,---r--ir---r----r----r---,--r--T--r--,
S O N
F
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M
A
M
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78
76
MONTHLY DATA
84
EXHIBIT 3, STORY,
This graph shows the'percentage change in the
Consumer Price Index between the same months from one year to the next
(January to January, etc,) versus the percentage change in the narrowly
defined money supply, Ml, also between the same months from one year
to the next.
The money growth line is lagged 23 months -- that is, e.g.
the datum for the 12 months ending January 1974 is plotted in December
1975 (23 months later).
The money growth series is lagged 23 months
to take into account that money supply changes have a delayed impact
on prices.
Twenty-three months was chosen because it best approximates
the average lag from money growth changes to changes in consumers'
prices.
The evidence indicates that inflation follows fairly closely
what happens to money growth 23 months earlier.
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EXlllBIT
3
C p I, YEAR TO YEAR PERCENT CHANGE OF
Ml MONEY SUPPLY, YEAR TO YEAR PERCENT
12.5
(LAGGED
23
MONTHLY DATA
CHANGE OF MONTHLY DATA
MONTHS)
10.5
r\
1-
I \
I
I
I
8.5
z
w
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6.5
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2.5 --'--~~...,.....,............,...,.....,......,...............,.....,............,...,.....,......,...............,.....,............,.......,..,....,............,..,....,............,..,..,..,..,................,..,...m.......,M"T"rr.
72
73
75
76
77
MONTHLY DATA
78
79
80
86
EXHIBIT 4.
STORY.
This graph plots actual percentage changes
in the CPI between the same months from one year to the next
{solid line) against predicted changes (dashed line).
The pre-
dicted changes were computed from past Ml growth and changes in
import prices.
The Ml growth used is measured between the same
months from one year to the next and is lagged 23 months.
Changes
in import prices, also measured over twelve month periods, are
weighted by imports as a percent of GNP and lagged one month.
Lagged changes in Ml growth were multiplied by .79 and the
changes in weighted import prices by 1.26.
added to obtain the predictor {dashed line).
The two were then
The multipliers
(.79 and 1.26) were d·erived by computer analysis estimating how
changes in money growth and weighted import prices affected inflation in the period 1966-1976.
It is important to note that the Ml multiplier exhibits
extraordinary long term stability.
its value was .76.
For the· 1947-1965 period
This is powerful evidence of the stability
of the relationship between lagged money supply and inflation.
In view of the evidence, it is naive to believe that
inflation can be licked without reducing money growth, or that
accelerating money growth will not accelerate inflation.
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
EXHIBIT 4
YEAR TO YEAR PERCENT CHANGE OF MONTHLY DATA
C p J,
0.791 * 11lr1P(T-23)
+
1.262 * PIMMPW(T-1)
14.5
12.0
I-
9.5
z
ILi
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u
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a..
I
7.0
\
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I
CPI
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r.,.,.
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4.5
00
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,
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PREDICTOR
I
rl
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2.0
72
73
74
75
MONTHLY DATA
76
77
78
88
EXHIBIT 5, STORY,
This graph or scatter diagram maps year-over-year
changes in the CPI last year against this year's average unemployment.
That the inflation rate is lagged one year means that the 1975 inflation
rate and the 1976 unemployment rate are labeled '76',
contiguous years,
The graph connects
The evidence plotted in this exhibit indicates that
apart from the Vietnam War period, accelerating inflation was followed
by increased unemployment.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Cp I
E»l!BIT 5
SCATTER DIAGRAM
fLAGGED l YEAR) vs UNEMPLOYMENT
m
YEARLY AVERAGE OF MONTHLY DATA
:r
X
1954 - 1976
12.0
"'....
V1
9.0
w
(!)
z
~
:c
u
I-
6.0
z
w
u
(X)
co
w
°'
n..
H
3.0
n..
66
(.)
61
0
-3.0 •·+-----·----.---
3.5
4.5
--·-·--T ··-·--·---··------,
5.5
6.5
UNEMPLOYMENT RATE
7.5
8.5
90
EXHIBIT 6
1
S[OR'(,
This exhibit graphs monthly yields on five and 20-year
U.S. Treasury bonds in the 1972-1977 period.
It is not surprising that
rates on these maturities tended to rise in 1973 and 1974, to fall in 1975
and 1976, and to move up a notch in early 1977.
closely changes in inflation.
These trends followed
An important principle of monetary economics
is that interest rates, at least longer term rates, will tend to follow
inflation rates -- rising with inflation and falling as inflation tapersoff.
Inflation accelerated in 1973 and 1974, tapered-off in 1975 and 1976,
but began to accelerate again somewhat in 1977.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
EXHIBIT
6
MARKET YIELD ON TREASURY SECURITIES
5-YEAR
9.00
&
20-YEAR MATURITY YIELDS
8.30
' '\
... ,
I
\
,,
'
\20 YEAR
\
'
t-
7. 60
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,,
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.._ •
\ I
z
ILi
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....
co
Q:
ILi
a..
6.90
6.20
72
73
74
75
MONTHLY DATA
76
77
78
92
EXHIBIT 7, STOR'f,
This graph plots percentage changes in the CPI measured
between the same months from one year to the next (CPI) and the Federal
funds rate (FFR),
It shows that monthly movements in the funds rate occur
very nearly in lock step with changes in the inflation rate measured from
the same month a year ago.
The evidence thus indicates that even short-
term interest rates are very powerfully affected by immediate past
inflation experience.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
EXHIBIT
7
CPI, PERCENT CHAtlGE FROM AYEAR AGO
vs
FEDERAL FUNDS RATE
13.0
(AT N,Y, BANKS)
11.0
...-✓,
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t-
9.0
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co
ti.,
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oi:
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,,
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/ FFR
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r-
~--
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3.0 ......~ - -................................~...........................................~................................................~..................................................~......73
74
76
72
75
77
78
MONTHLY DATA
94
EXHIBIT 8 STORY,
1
"average homebuyer"
This exhibit graphs the interest rate which the
paid
to secure a mortgage during the last two
and one-half years, and the interest rate on long term (20 year)
government securities during the same period.
"stickiness" of mortgage rates.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
The graph reveals the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
EXHIBIT 8
EFFECTIVE YIELD ON CONVENTIONAL NEW HOME MORTGAGES
MARKET YIELD ON ·20-YEAR TREASURY SECURITIES
9.50
9.00
t-
....
8. 50
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-+-....-..-r-,--r-r-r--r---r-....--r--.......,r-,--r-r-r--.---r-....--r--.......,r--,--r---.-........-.--r-....-..-.-,,--,--..-.
75
76
MONTHLY DATA
77
78
